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Incorporating Free Cash Flow Yield in Dividend Analysis Could changing the way you think about yield potentially lead to risk/return benefits?

The importance of dividend investing is a widely studied topic by academics and market participants alike. Our own research has shown that dividends are a key contributor to equity returns. Nearly half of the total return of the S&P 500® came from the reinvestment of dividends and the effect of compounding over the 28-year period ending December 2016 (see Exhibit 1). From 1928 to 2016, dividend income return contributed 43% of the monthly total return of the S&P 500. According to a study done by Robert Arnott, for over 200 years, ending in 2002, the U.S. stock market generated an average 7.9% total return on an annualized basis, with dividend reinvestment contributing 5% per year.

In addition to contributing to total return, dividends can also act as a cushion in down markets. Numerous studies have demonstrated that dividend-paying companies have historically exhibited less relative downside risk and take less time to regain losses, therefore delivering higher risk-adjusted returns over the long-term investment horizon.

Our own research confirms that equity markets tend to reward dividend payers over non-dividend payers, with the former outperforming the latter on average. Between December 1990 and June 2017, dividend payers generated higher risk-adjusted return than non-payers and the market (see Exhibit 2). 4 Over a longer time horizon, the outperformance is even more pronounced. In a study of a 90-year return history of dividend payers and non-dividend payers, dividend-paying stocks accumulated over three times the terminal wealth when compared with non-dividend payers.

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