Dividend-paying common stocks and “income generating strategies” are attracting nonprofit executives’ attention. And with good reason: The stock market has been volatile and many finance committees have been disappointed with the rates-of-return of their investment portfolios.
It has been more than 50 years since stocks provided a higher yield than Treasury notes. The matter rests on risk versus reward. Common stocks currently offer higher yields but entail obvious risks. But which equities should a conservative nonprofit choose?
Companies that not only offer dividends but have a history of increasing them for five, 10 or an even greater number of years have provided growing income streams as well as higher total returns than stocks that do not grow their payouts and those that do not pay dividends at all.
There’s a catch: that pesky investment policy statement. It doesn’t say anything about dividend-paying common stocks or “income generating strategies.” Rather, it addresses the total rate of return that is needed to achieve the organization’s objectives. Are dividend-paying common stocks and “income generating strategies” appropriate? How might they fit into the asset mix?
According to Robert Shiller, professor of economics at Yale University, real returns from equities (assuming reinvestment of dividends by the company) have been 6.27% since 1871. In the same time frame, dividends have accounted for 70% of the total annualized real return, versus 30% for price appreciation.
High dividend yields are often signaling a company doesn’t have a good use for the funds. Yet, many companies with high growth rates, e.g. technology companies, don’t offer dividends because they need the capital.
With interest rates at historic lows, nonprofits might consider dividend-paying common stocks as an alternative to fixed-income and/or appropriate for part of the fixed income allocation.