Investors Prefer Dividend-Paying Companies in Market Downturns

It may not be comforting, but individuals are rewarded over the long term for investing in stocks because stock prices can go up or down. Short-term market volatility and uncertainty creates a risk premium to entice investors to buy and hold stocks. It is important to note, however, that all stocks do not react equally to stock market moves.

One attraction of dividend-paying stocks is their regular cash income. Your total return from investing in stocks is composed of any capital gain or loss along with the income generated by your investment. Dividend-paying stocks may not offer as much capital appreciation potential as higher growth, non-dividend-paying stocks, but they tend to offer some downside protection when the market swoons.

There are at least two elements that contribute to the downside protection. The obvious element is the regular quarterly cash dividend that investors receive from dividend-paying stocks. During overall market declines, the dividend yield will actually increase for stocks, potentially drawing in fresh income-seeking investors or at least keeping some investors from fleeing a given stock. The greater the stock decline, the higher the yield grows. As long as a company’s future looks promising and its dividend is perceived as secure, the regular income stream is an attractive enticement to wait for an improvement in the market environment. The other consideration is the signaling element of the dividend payment.

Dividend Payment as Signal

Companies have contractual obligations to pay interest on borrowed money, but there is no legal requirement to pay cash dividends to shareholders. The board of directors determines whether to pay a dividend, as well as its amount and timing. The dividend payment is an important signal from the company to investors. Dividends convey information about future earnings, cash flow and capital investment expectations from management and the board of directors. In general, unexpected increases are good news and unexpected decreases are bad news.

Research from Fuller and Goldstein in the paper “Dividend Policy and Market Movement” asserts that the commitment to pay dividends allows the firm to send a signal that the future prospects for the firm remain positive. More importantly, investors know when to expect the signal. A dividend-paying firm has a relatively regular schedule regarding dividend declaration, record date and payment. Stock prices reflect market expectations. When investors have more certainty regarding the expected return, as with receiving dividend payments, more value (a higher premium) is placed on the stock price.

Dividends’ Value in Up & Down Markets

The authors take the theory a bit further by proclaiming that investors value dividend-paying companies (and management’s signals) more in down markets than in up markets. “Whether the signal is the maintenance or increase in future earnings or the reduction of waste of free cash flows, the ability to signal should be most valuable in periods of poor overall stock market performance.” In the study, down markets are defined as months that the S&P 500 index had a negative monthly return, while an up month was when the S&P 500 had a positive monthly return from 1970 to 2000.

There were 217 months in the sample where the S&P 500 had a positive return (“up markets”) and 155 months where it did not (“down markets”). The data showed that, overall, dividend-paying firms outperformed non-dividend-paying firms by 0.37% per month. During up markets, non-dividend-paying stocks returned 3.72% on average, while dividend-paying stocks had an average return of 3.88% or a difference of 0.16% per month. During down months, however, non-dividend-paying stocks lost 3.03% on average, while dividend-paying stocks lost just 2.13% or difference of 0.90% per month.

The authors of the study also looked at the performance of dividend-paying versus non-dividend-paying stocks during bull and bear market periods between 1970 and 2000, as defined by Ned Davis Research. Overall, there were 259 bull months and 113 bear months in the study. During bull markets, non-dividend-paying stocks returned 2.09% on average per month, while dividend-paying stocks had an average return of 2.23% or a difference of 0.14% per month. Again, during bear markets the difference was even greater: Non-dividend-paying stocks lost 2.37% on average, while dividend-paying stocks lost just 0.53% or a difference of 1.84% per month.

Impact of Dividend Announcements

The authors of the study also looked at the impact of dividend announcements, increases and decreases over different market environments. Price reactions to dividend increases are less in up markets than in down markets. In addition, dividend decreases have smaller negative returns if announced during down markets than up markets. Further, firms that maintained their current dividend payments in down markets experienced positive abnormal returns. Thus, when firms cut dividends when the market is doing well, it is a clearer signal that they are having problems. However, if firms cut dividends when the market is doing poorly, there is less information in the dividend cut or the market may view the cut as an appropriate step by management to undertake given current economic conditions.

The authors calculated the abnormal return for the five days around the announcement day of a dividend change. Overall dividend increases generated a 1.013% positive excess return. However, a dividend increase generated only a 0.857% positive excess return during up markets, but a 1.206% excess return during a down market.

Dividend decreases resulted in an overall –0.360% excess loss over the whole study period. A dividend decrease resulted in –0.375% excess loss during up markets, but only a –0.324% excess loss during down markets.

Even a decision just to keep the dividend unchanged conveys positive information to investors, especially during down markets. A no-change dividend declaration resulted in an overall 0.102% excess gain over the whole study period. A no-change dividend announcement resulted in 0.046% excess gain during up markets and a 0.17% excess gain during down markets.


The study results paint an interesting picture for investors to look at. It may not be emotionally easy to hold onto to your stocks during a bear market, but dividend-paying stocks can help reduce some of that angst.

From the June 2015 AAII Dividend Investing newsletter.


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