The S&P 500 Dividend Yield Is Low, but the Next 10 Years Are Simple Math

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The last time the S&P 500 dividend yield was sitting at 1.17% was in February of 2001. Many investors remember the stretched valuations 23 years ago, and even more so, how the following year proved to correct that exuberance. While stock prices are currently hovering around all-time highs, us dividend growth investors targeting a yield of 2.5-3% may find challenges in this environment.

Given this, and the uncertainty surrounding the recent presidential election, Greg spends episode 41 reviewing the foundational pillars behind our investment strategy. Even with low yields, the next 10 years of performance can be boiled down to relatively simple math. As GDP expands, corporate earnings grow, which in turn gives investors increasing dividend checks. Through several illustrations of what that looks like in your portfolio, Greg concludes that the dividend growth strategy is alive and well. Later, he reviews some recent actions we have taken, highlighting decisions on selling part of Emerson ($EMR), adding to Hershey ($HSY), and starting a position in Union Pacific ($UNP).

00:00 Introduction to The Dividend Mailbox
00:46 Current Market Overview
001:54 The Drivers Behind The Dividend Growth Strategy
005:10 Historical Performance Analysis
007:52 Future Predictions and Assumptions
010:28 Dividend Growth vs. Buybacks
12:15 Portfolio Growth & Return Illustration
20:16 Market Yields, Challenges, and Opportunities
27:46 Our Recent Portfolio Actions
35:16 Conclusion and Final Thoughts

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Transcript

[00:00:11] Greg Denewiler: This is Greg Denewiler and you are listening to another episode of The Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks. When they grow over time, a funny thing happens, you create wealth.

Welcome to episode 41 of The Dividend Mailbox. If you've been paying attention to the market lately, the dividend yield of the S&P 500 has reached basically an all-time low of 1.17%. Part of what that implies is it is getting a little bit more challenging to find situations where we can earn 3% and continue to get the dividend growth that we want. We're going to go over how we're looking at it, how we're still finding opportunities, and specifically how we think we could still get a 3% yield on a portfolio and still grow it by 7% a year, which is a double in 10 years. That'll be the first part of the podcast. In the second half of the episode, we're going to look at a few actions that we've taken. We've reduced a position, we've added to a position, and we've started a new position. It should give you a little bit of an idea of how we execute strategy and why we think dividend growth is still intact. So, with that, we will get into what's going on in the marketplace right now.

As of the first recording of this episode, The S&P 500 is up 25% year to date, and if you look at last year's returns, you look at how it's done in the last several years, it gets pretty easy to step back and say, well, how long can this continue? We just came off of a highly polarized election, to say the least. You've got basically 51% of the people that are happy and 49% of the people that are not happy. So, one of the things I thought would be a good exercise to do is just look at, okay, has anything really changed? Because when you spend 40 episodes, and now we're on 41, pitching a story and you try to really get across the point that this is a concept that can create wealth over time, you better make sure your story hasn't changed.

And one thing that came up was an article from Barron's that brought up the S&P 500 dividend yield right now is really knocking on the door of a historic low. The last time that the S&P had a yield of 1.17% was back in February of 2001. Well, we all know 2001 to 2002 was not a good period for the market. What we're going to do now is we're going to continue that concept: Can the dividend of the S&P 500 grow by at least 6% a year for the next decade? As I hope you see when we're at the end of this illustration, there is really just simple math that things have not changed that much. 

The whole market over the last century is relatively simple math. It's 6% GDP growth. It's 6% earnings growth. And roughly it's 6% dividend growth of the S&P 500. They all sync up because corporate earnings are driven by the economy and dividends are driven by corporate earnings. It's almost that simple. Now, the numbers aren't all exactly 6%, but they're relatively close.

If you've been listening to our podcast for more than one episode, you will probably say, “Well, wait a minute. They use 7%. So, why are we talking about 6%?” Well, the S&P 500 is what we work off of, that's basically our foundation. What we're really interested in is if we get a dividend growth rate of 6% a year on the S&P 500, that gives us a pretty strong indication that we're going to meet our goals of getting 7% or better.

So first of all, let's look at what happened historically. We'll start with just the last decade from 2013 to 2023. The dividend has grown from $35 for the S&P 500 to slightly more than $70, which happens to be a compounded growth rate of 7.2%. If we look at earnings, because we have to have earnings growth to have sustainable dividends, they have gone from $100 to $192, 2013 to 2023. And that is a 6. 7% annual compound rate. Okay, the last 10 years have been good. Well, what about going back to 1988? And the reason why I use 1988 is not because that's the number that works best for the story that I'm telling. It's because Standard Poor's website, they have a lot of data on the S&P 500 and it goes back to 1988. So that's why we use that number. So, from that period, The dividend grew from $9.75 cents to currently it's $73. That is 5.8% for 36 years. It has grown a little bit less in the last several decades, but the good news is it's still basically growing at the rate of the economy, which is a significant point that we're going to get to a little bit later. If you look at earnings, from 1988 to the present, earnings have grown by 6. 3% a year, roughly the same amount. So, now we're getting the numbers, they're really tightening up and we're fairly close. Earnings follow GDP growth and dividends follow earnings growth, it all really syncs together. One of the explanations why dividends grew slightly less than earnings by about a half percent a year— it's not huge, but it over time does make a difference. Back in 1988, the dividend payout ratio was 41%, meaning out of every dollar, the average company in the S&P 500 paid out 41 cents. It's averaged 43% since 1988, so, it's been up a little, down a little, but if you look at the current payout ratio, it's 35%. So, it has trended a little bit lower. That right there helps to explain a big piece of why dividend growth has been slightly less when you take it out for a longer period of time.

But now we're going to get into something that becomes a big factor in how we potentially can predict the future. The only thing we have to do is really make two assumptions. And this is the good news because they're really very simple. We're just going to assume that the growth of GDP continues on its long-term trend path of 6% a year, and that includes inflation. Historically, it's been very consistent, even in the collapse of 2008. The economy was shut down for all intents and purposes, basically, GDP dropped by 35% in one quarter. It only took it two years to fully recover. I encourage you if you have any doubts whether the economy can continue to grow at that rate, just look at what's happened over the last hundred years, the chart is pretty compelling. That gives you a pretty strong indication that earnings are going to grow by the same amount, or roughly close to it. That means we should at least get 6% growth out of earnings. Now, if we use the current earnings number of the S&P 500 of $211, if they grow by 6% a year, then in 10 years, the S&P 500 will have earnings of $388. Now, it gets really simple. If you use the current payout ratio of 35%, that's a dividend of $136, and that means that from today, we're at $73 currently—that's 6. 4% a year. Right there suggests that it's not going to be that difficult to continue to grow the dividend. And here's one nice kicker: What if the payout ratio actually increases back to its longer-term average of 43%? Well, then you'd have a dividend of $167, or in effect, 8. 6% a year of compounded growth in the dividend. There, you get into a number that has come close to matching what we've had in the last—in fact, slightly better than what we've had in the last decade. Going forward, we may actually have a little bit better dividend growth. 

Well, one of the questions that comes up is “Okay, but companies have been doing more buybacks.” Most analysts will say that they will count a buyback as the same or virtually the same as a dividend because it's a return of money to the shareholders. The only thing I'm going to say about that is the problem with buybacks is a lot of companies do acquisitions and they issue more stock when they do an acquisition. Yeah, they buy the stock back, but in the long run, they end up with more shares outstanding because down the road they issue more. And the other problem with buybacks is there's a point where you don't really want to buy it back because it's too expensive. You want to look for more opportune times to buy back, and if you recall, one of the companies that's had some great discipline in regard to buybacks is William Sonoma. It’s one of the companies we've talked about a lot in the past, they've been very disciplined and when the stock is up, they don't buy any back. A lot of companies don't use that discipline and they tend to pay more. But the other point I would make is all things being equal, even though companies may not give you quite as much cash going forward, it could help the growth rate a little bit because buybacks lower the number of shares, which means that increases earnings per share by a little bit. All things equal, that means the dividends going to grow slightly faster, but here we're kind of getting into the weeds. We're going to keep it simple. 

Let's just say that you buy into our, “In the next decade, we can get 7% dividend growth.” What does that look like? On the surface, it doesn't sound that exciting. In fact, in this environment, with what's happening in the growth stock sector and some of the big, largest cap companies in the S&P 500, really in the world—Apple, Amazon, Microsoft, Nvidia, where these stocks are having huge gains, 7% a year, just sounds extremely boring. Well, here's how boring it really is. If you have a million-dollar portfolio and you start out with a 3% dividend yield— again, that's a really important number. We've hounded on that number a lot in the past. That's kind of our target, it's between 2 to 3%. That's where you get some additional income, but you're still in the zone where companies can grow their earnings, and that's where you get the sustainable growth from.

So, if right now you assume a 3% dividend yield, first of all, we're just going to say it grows at the rate of 6.4% because that's our 35% payout ratio, and we're just going to assume that everything stays the same. Well, just for illustration purposes, if you have a million dollars, you start out at 3%, that's $30,000 a year. For the next 10 years, you get a little over 6% growth in the dividend. Your $30,000 has grown to $56,000. At that point, everything's the same. The portfolio is still a million. You're now earning 5.6% on your money. Well, what I'm going to do is I'm going to use a simple average. We started at $30,000, we ended at $56,000 in 10 years. So, just take the average of those two numbers, that's $43,000. Over 10 years without any compounding, which is a significant number in and of itself, that is $430,000. So, right there without any price movement at all in your portfolio, you've just earned 4.3% a year on your money. But we're going to assume that your portfolio, at the end of 10 years, still has a 3% yield based on the current value of it. What I mean by that is if you went in and bought all the stocks that you owned in that 10th year, if you were starting over or from scratch, you would get a 3% dividend yield based on what they're paying. That means that your 1 million is now worth a little over $1.8 million, because if you divide $56,000 by $1.8 million, that is 3%. So, if you add the $1.86 million with the $430,000, you're now up to $2.3 million. So, you've more than doubled your money and that's just looking at dividend growth of 6.4%. That's our 35% payout ratio. 

But let's just assume that we get slightly faster dividend growth, and it's 8.6% a year. That means that the payout ratio has gone back to 43%, or we've got better picks. Under that assumption, your 3%, your $30,000 grows to $68,000 in 10 years. Same process, you take that average over the 10 year period, just average those two numbers, $30,000 to $68,000, and you get $49,000 a year or $490,000 over a 10-year period without any compounding. You've gotten half your money back, that's one way to look at it. You've made 50% on your money and here's a better way to look at it. If that portfolio at the end of the 10th year is priced at a 3% yield, and you're getting $68,000, now, just the price appreciation is a little under $2.3 million. You've gotten roughly $500,000 in dividends. Now you're up to $2.7 million. You've almost tripled your money over a 10-year period. Your expectations are just that the economy grew by 6% a year, and all the dividend did was get back to the payout ratio that it's averaged for the last several decades. Pretty simple assumptions and another part about GDP growth, that 6% number, you get half of that just from inflation because the long-term average of inflation is about 3%. The point here is we don't have to make any wild exaggerations or hope this happens or hope that happens, and things can go pretty well. The dominoes just have to fall and for the last century, they have been. 

And then, I'm going to give you another scenario. You send me an email and say, “The stock market valuations are just way extended. What if the debt problem that we have, what if it ends up slowing down the economy? What if tax rates eventually go up because we have to pay the debt down or we have to use that to finance the increasing debt burden? So we're set up that this next decade, the portfolio is going to be lucky if the S&P 500 goes up at all.” I mean, we can go on and on of what could potentially create what we're going to call a dead decade. Well, I have 1 question for you. Would you rather own an NVIDIA or something else that is trading at an extremely high multiple and the S&P 500 is not performing and maybe the market gets a little less excited about growth? Would you rather be in a situation like that, where maybe you have a dead decade and you have no return, your stock basically doesn't move, or even goes down? Or would you have a situation where you've received almost half your money back in cash? If you're getting a cash flow, you care a lot less, that's all I'm going to say. It really helps prevent you from having a long period of time where you have no return on your capital, and that's what happened in the 1970s. For that decade, the S&P500 didn't move at all, but there was still a return from the dividend yield. I will tell you that if you get a little bit higher inflation, that actually helped the dividend and corporate earnings growth in the 1970s, just because inflation inflated the numbers. It really is a strategy that helps protect you, and it really works no matter what happens. You have to have discipline, you have to be patient, and it just takes time for the compounding to really work, but I would venture to say that it is more predictable. It's just a simple stick to the middle of the road and hitch your wagon to that growth of the economy. If you're willing to commit to that GDP growth, then the dividend growth story is alive and well.

Now, the flip side, which we're going to get into in the back half of this podcast, is it's getting harder and harder to find valuations that appear to be attractive, where we can go in and enter a position that we like. Now, there are some things out there, we're going to mention a few that we have still been doing here recently, but this kind of goes back to that Barron's article about, hey, no matter how you put it, the market can be perceived as somewhat expensive right now. That's part of why dividend yields are so low. 

The top 10 companies in the S&P 500 represent 35% of the index, and the average yield on those is 0.37%. Several of them, three to be exact, yield nothing. One of them yields 0.01%, that's NVIDIA which is, depending on what day it is, either number one or number two in market cap. And then you got several of them that only yield 0.2% to 0.5%, you know, Apple is 0.25%. So, the yield is very low on the most valuable companies in the world and the companies that make up a significant part of the index.

But now what I want to do is convince you that those top names are not the entire market. One thing that could very well happen is that as those top names go, the rest of the market may not necessarily follow. You saw that in a significant way back in 2001 when the tech sector took a hard crash and the broader market actually did fairly well. If you go to the next 10 companies of the S&P 500, you immediately start getting into smaller capitalized, you know, they have less of an impact on the index. Number 11 on that list is 1.3% of the index, and you get to number 20 on that list, and it's 8% of the index. You add them all up, they represent 9.9% of the S&P 500. So, already, you're starting to get into much better diversification, but the important thing is you take your yield on those next 10, it goes from 0.37% up to 1.7%. Even in that list, you've got a few of them that have a fairly minimal yield. You've got one of them, MasterCard's yields a half percent. You've got Eli Lilly, it's 6%. You've got several of those that even have smaller yields, but you are starting to get into a few like ExxonMobil, 3. 2%, and Johnson & Johnson, 3. 2%. You are starting to get into some higher-yielding situations. 

And now we're going to look at the final part of this, which is the next 10 companies. And here, it's 5.9% of the index. They're getting smaller. These are still big names, still big blue-chip names: Walmart, Bank America, Merck, Coca Cola, Chevron. Now your dividend income has gone up to 1.86%, so it continues to trend higher. Several names on this list actually yield 3% or more, and you got one Chevron at 4.1%. Well, you might be saying, all right, well, that's great, but 1.8% is not three. So, what we did was we went through and we cherry-picked the highest-yielding companies out of the first 30 in the S&P 500 index, and we grouped those into a group of 10. Here's what happens: number one, you've got a market cap of 7.7%, so there's nothing in there that's a significant weight in the index. You've got a more diversified base as far as just exposure of one company going down in value. You've got dividend yields that have a low of just a little bit above 2%, but you go all the way up to 4.1%, and you got a lot of 3 percenters in there. If you add them all up, just do an average, it's 2.96%. There's our 3% number. You look at the names of these companies: Exxon, Johnson & Johnson, Merck, Coca Cola, Chevron, Home Depot, Procter Gamble, JPMorgan Chase, Bank of America. These are big blue-chip names. But you may be thinking, “Well, okay, these are all dinosaurs, not the kind of names that were on the first 10— Apple, NVIDIA, Microsoft, Amazon. So, I don't really care about your 3% list.” I'm not going to imply what these companies are going to do for the next 10 years, but what I am going to tell you is what they've done for the last 10. Collectively, as a group, they've grown their dividends by 166% over the last 10 years. Here's what this means: number one, we went through a difficult economy in 2020, which everybody's fully aware of, and these companies continue to raise their dividends over time. Number two, here's where you get into some pretty phenomenal numbers. If you use that same— you started 10 years ago at $30,000 and you own these 10 names, your income now is up to $80,000. We do our simple little average and we get $55,000 over that 10 year period. You have earned $550,000 over that period of time, just using an average. And if we use the same— today that portfolio is priced to earn 3%, that is currently valued at almost $2.7 million. Your total account value is a little over $3.2 million. So, you've turned $1 million into over $3 million in 10 years, and it's just a bunch of old sleepy names. But they generate cash flow and they continue to grow it. My point of that example is I think it's still possible to grow your income and a 7% number is reasonable, just slightly above what the economy grows by, because I just showed you 10 names that you could buy today. I'm not implying that these are the 10 names that you should own, but we do own a few of them that are on that list. If you use discipline and you stick to the core concept, focus on sustainability, it's still quite possible. And I actually feel pretty optimistic that in 10 years, assuming you're going to be listening to a number, whatever that will be, 132, the story is still intact.

So now, we move into what we've done with a few situations that we hold, and again, the main objective of this podcast is not to give you specific buys and sells, but we do it as mostly educational to try to help give you an idea of here's how you actually execute the strategy, which is the most important thing. Whether you want to do it yourself or if you're looking for ways to grow your dividend income, just some things to keep in mind as you look for alternatives, which hopefully you would maybe consider us as an alternative.

So we'll do a sell, add, and then buy. So, we'll start out with the sell. We've mentioned this one in the past. We sold a small piece of it several months ago, and it's Emerson Electric. Well, in the last few weeks, we sold another half of it. We sold it at around $118. It's been profitable, but it's lagged the S&P 500 over the period that we owned it, and the reason why, they announced earnings. The earnings announcement actually was positive, they've got growth, they've got some margin expansion, they've gone through a big transition. The earnings estimates are pretty strong for the next few years, they're almost $6 for next year, $6.47 for 2026, and they're up to $7.12 for 2027. And in fact, as of this recording, the stock has moved all the way up to $130, so it continues to do well. That's the reason why we kept half of it. But you just look at that and you say, why sell it? Well, one of the problems is, we're after a total return story and we are after dividend income. I have no regrets of selling half of it, because this is where it was a little disappointing. This company is a dividend aristocrat. They've paid a dividend actually for more than 50 years. It's been around for a century. It used to be a really nice dividend grower and it fit our strategy. But if you remember in a previous podcast, we were waiting for the next dividend announcement. It had been four quarters and they were due to announce what they were going to do for the next dividend. Well, they announced a $2 billion share buyback, which they have free cash flow of $2.5 billion plus, so they've got the money to do the share buyback. But they raised the dividend from $0.525 a quarter up to, and you better be sitting down for this one, $0.5275. They raised it by a quarter of one cent. Well, we look at that and go, clearly, the mindset and the culture of this company appears to have changed because a quarter of one cent, it is a fraction of that $2.5 billion in free cash flow. It equates for one cent for the entire year, and that's $5.7 million. I mean, it's like, come on. Clearly the only reason why you raise that dividend is to stay on the dividend aristocrat list. Otherwise, you're focusing on growth now, and that's where your mindset is. There's nothing wrong with that, but when we're trying to deliver dividend growth over time, it's not here. Now, maybe in the future that changes, but given the fact that their profitability, their cashflow, their debt to equity ratio is down to 35%, I can't find a reason of why they wouldn't have paid more. Long term investing is really all about discipline and knowing what success looks like, and for us, success in 10 years is doubling our dividend income. So, it doesn't make sense anymore. 

Now we'll go to the add—we actually added to Hershey, it has come down some, they've got an issue with cost of goods sold. Cocoa—we've, we've talked about that. Cocoa prices are high. It is starting to affect their cost of goods sold a little bit more. Consequently, earnings are down some and we're basically using this as an opportunity to buy more. Hershey has a 3.1% yield and continues to grow it. We think that it's a company that we want to own. Over time, they can figure out their cost of goods sold situation. Cocoa prices are already showing signs of coming down because you've got more production out there, which is what happens in commodities when they go up. People start producing more, and ultimately, high prices are the best cure for high prices. Here's another case where it's a company that's been around for a hundred years. The current CEO has been with the company since 2017. She's well familiar with the culture, with how to manage the business, and if you look back historically, this company's done a great job of managing their expenses and cash flow. The cost of goods sold usually is very stable. They've got long-term relationships with growers but if you have a price that goes up and stays up for a long enough period of time, some of your prices get renegotiated. If you've done any hedging, some of that stuff starts to come off. It's very understandable why cost of goods sold have gone up by almost 4%, but that's also something that potentially becomes a positive down the road. We're just betting on simple reversion back to the mean. We added to it around $174, we first started buying it up in the mid $180s, and if the stock comes down some more—right now we have about a half position in it. If we get any more weakness, we will look to add to that one. 

And finally, Union Pacific got down to $228. We've had a buy target on it of $210 but we've been way above that now for quite a while. With some of these situations, you have a discipline of what you're willing to pay for something and it gets close, but it never quite gets there. So, we decided we're going to take a small position in it at $228, get into it, and then try to buy it cheaper later, because I really want more. But I also know that long term, this is a company I have a lot of confidence in. It's going to give us long-term returns, and if I pay a little bit too much for part of it, oh well. Lo and behold, since the infamous Trump trade after the election, some of the economy-type situations have done well, it's caught part of that rally. It's already moved up from where we bought it, but hopefully, we'll have another shot at it. We're in this for the long haul and we'll see what happens over time.

So, overall, just to conclude through all this. It's getting harder because the overall market has traded higher and yields have come down on virtually everything, but it's still possible. We think that it's a pretty easy reach to get to the fact that the next decade should be pretty good for dividend investing. It's really somewhat simple math. Now, looking at individual companies where we can get sustainable dividend growth, that's far from simple. You need to stay on top of your portfolio and how there are things that you can always be doing to help ensure that you get the dividend growth that you're looking for. But overall, corporate America is pretty good at adapting to its current situation. As long as consumers continue to spend, then Pepsi sells more Pepsi, people buy more Fritos, you still buy Band Aids, and you still use gasoline. All the long-term incentives are there, and we have to have at least a relatively healthy corporate America because everything builds off of that. The concept is very straightforward, and it's just GDP growth, just hooking our wagon to that. Even though the market's expensive now. And there may be challenges going forward, the dividend growth strategy can work well in virtually every market. If we go a few years where we don't get much price appreciation, or we even get a correction, then the income becomes really important. You're going to be glad that you're getting a cash flow and it gives you the chance to reinvest. Can we own the wrong sector? Can it lag? Sure. But sooner or later, if you get the income growth, you're going to get the price appreciation. And if you believe we're going to get GDP growth, then it's a story that can create a lot of wealth.

If you enjoyed today's podcast, please leave us a review and subscribe. If you would like more information regarding dividend growth or our investment strategy, please visit growmydollar.com. There you will find previous episodes and also our monthly newsletter. If you have any questions or anything to add to today's episode, please email ethan@growmydollar.com. Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks including dividend stocks are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.