Dividend strategy is easy to understand and practice, and nothing mysterious about it. Dividend generally refers to the cash distributions made by a stock issuer, as illustrated in the graph below, which shows the long bull market of the S&P 500—a core index for the U.S. stock market. Over the three decades since the beginning of the 1990s, the S&P 500 price index (exclusive of cash dividend) recorded 1,123% of aggregate return, while the S&P 500 total return index (dividends reinvested) achieved an amazing 2,273%, more than two times of the former. Thus, a conclusion can be drawn that among the three determinants of the total return on stock investment—dividends, profit growth, and valuation appreciation, dividends play a decisive role in shaping the overall return of the U.S. stock market across its long prosperity cycle. The decades-long bull market has fully demonstrated the power of compounding through dividend reinvestment.

High-dividend stocks are attractive to long-term investors, not only because dividend payments are another direct source of income in addition to the capital appreciation but also because a consistent high dividend is an important indicator of strong cash flow and stable profitability. The growth of major developed economies is slowing down, because of the aging population and the weakened role of technological innovation. The stock market valuation is already at a historic high amid persistently low interest rates. Profit growth and valuation appreciation have only a limited role in driving up the expected return of a stock. Therefore, dividends will be increasingly decisive for stock return.

Academic researchers have found that dividend helps predict a company’s future performance, and a portfolio of high-dividend stocks can outperform a mature market for an extended period. We have observed the dividend strategy has become popular among global investors in recent years, and the AUM tracking or benchmarking against dividend indexes is expanding.

In my view, the value of dividend strategy is reflected in three aspects:

(1) Value from Long-term Asset Allocation

Looking at the fundamentals, listed companies that pay long-term, above-average cash dividends are more likely to have solid profitability and abundant free cash flow, and mostly are leaders in mature industries with a well-defined competitive landscape. Characterized by sound operation, strong power to select downstream clients, and higher risk resilience over peers, these companies present net profits in cash rather than account receivables in their financial statements, ensuring high cash dividends. A portfolio comprising a basket of stocks issued by these companies can spread risks and deliver an annual cash dividend higher than the return of wealth management products. Such a portfolio is attractive to long-term capital that trades less frequently and focuses less on market volatility, especially institutional investors adopting long-term asset allocation strategy. It is also feasible to adopt the dividend strategy simply by investing in indexes.

(2) Value from Defensive Equity Investment

Benjamin Graham, known as the father of value investing, shared his insight on the dividend strategy in his investment principles, pointing out defensive investors should invest in large companies with robust finance and stable dividends. One of his seven stock selection principles requires that the company has paid a cash dividend for at least 20 years in a row. In the past three decades, A-share market has witnessed several wild swings that dragged down the rate of return to a level unacceptable to investors of low tolerance. The dividend strategy provides a defensive approach to equity investment in the following two senses:

First, take the CSI Dividend Index as the representative of dividend strategy and compare it with the A-share market benchmarks CSI 300 and CSI 800 total return indexes. The former has achieved higher aggregate return and, more importantly, lower volatility over the past ten years. This illustration means that investors adopting dividend strategies will experience less volatility for each unit of return; hence this strategy is more “cost-efficient” in terms of the risk-return ratio, demonstrating advantages for people seeking stable returns.

Second, the A-share high-dividend stocks face a relatively controllable downside risk due to their industry structure. Again, we will use the CSI Dividend Index as an example. Its constituent stocks come mainly from the financial, real estate, consumer staples, discretionary, utilities, transportation, and middle and upper-stream cyclical industries. In recent years, the financial, real estate, utilities, and transportation industries have seen low stock valuations. Major companies in these industries have reinvested their net profit to maintain steady growth while distributing a more significant portion of profit to shareholders through cash dividends. Their strong certainty of dividend payments makes their stocks a “bond-like” asset class. In the traditional cyclical industries, leading companies have gradually integrated their critical resources, cut production costs, and improved operational efficiency, gaining a competitive advantage from the economies of scale. Hence, they can absorb the cycle impact and remain profitable even during an industry downturn. In the consumer industry, which is less susceptible to cyclical fluctuations, companies have performed continuously well amid the consumption upgrade and the rise of domestic products. In addition, the dividend strategy screens out high-dividend stocks with unreasonably high valuations to reduce the risk of valuation falls and is a valuable tool for seeking certain yields in a highly-uncertain market.

(3) Value from Style Rotation Transactions

The dividend strategy can also benefit from style rotation. High-dividend sectors, such as the financial and cyclical industries, correlate highly to economic cycles. From a historical perspective, when market liquidity is adequate during a recovering economy, these industries will prosper from increasing domestic demand and rising exports. This will drive up stock prices as market expectation becomes more favorable. Using the index tools of the dividend strategy, investors can benefit from the trading opportunities of style rotation arising from cyclical changes. In this sense, the dividend strategy is both defensive and aggressive.

Above are some of my reflections on the dividend strategy, and I hope investors interested in this strategy will find it helpful. Portfolios of high-dividend stocks have a clear logic and are easy to construct. As a famous saying goes, simplicity is the best virtue. Likewise, we should seek one or two simple but crucial tools and use them wisely to succeed as an investor. Of course, this is done on the basis of solid research and deep thinking.