The importance of dividends in long-term investing

A recent research report confirms that dividends are a key contributor to long-term sharemarket returns in Australia.

The January 2010 MSCI Barra Research Bulletin: What Drives Long-Term Equity Returns breaks down the total returns of international sharemarket returns between 1975 and 2009 into the following components:  inflation, dividends and real capital gains (price to book and real book value).

The MSCI World Index annualised gross index return over this timeframe was 11 percent, with inflation at 4.2 percent being the largest contributor and dividends contributing 2.9 percent to the total return. The report found that dividend income for international shares was on a downward trend, falling from 4.6 percent in the 1970s to 2.2 percent over the last decade.

The price to book growth of only 1.5 percent over the 35 year period belies the fact that this ratio was actually a key contributor to total international equity returns over each decade. The report states that this is because: “the price to book value component represents the source of volatility in the overall equity return.”

Australian sharemarket returns tell quite a different story. Over the 35 year period the  dividend return was 4.3 percent out of a total MSCI Australia Gross Index return of 14.3 percent. Price to book growth contributed 2.7 percent while Real Book Value Growth contributed 1.2 percent to the total return. This period takes into account the high inflation periods of 1975 to 1979 and the 1980s when inflation accounted for the bulk of the total return. 

MSCI Barra attributes Australia’s and the United Kingdom’s outperformance between 1975 and 2009 to higher inflation rates and dividend yields. In the noughties decade, Australia (9.1 percent) and the United Kingdom (0.9 percent) were the only regions to produce a positive return.  During the last decade Australian dividends comprised 4.1 percent or almost half of the total return.