When Selecting Dividend Stocks Which is More Important – Dividend Yield or Total Return?

When considering dividend-paying stocks, some investors tend to select stocks with high dividend yields rather than the long-term total return. However this is not a winning strategy. Instead of falling into the so-called “yield trap”, investors are better off picking stocks based on total return over the long-term, according to a research report by Invesco published earlier this year.

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Source: Investment Insights: In the Long Run with Dividend-Paying Stocks, Invesco

Among the S&P’s ten sectors, traditionally the utility sector has had the highest dividend yield. But the sector ranks the sixth in terms of total return during the period shown in the chart above. On the other hand, the consumer staples sector has lower yield than the utilities sector and is comprised of many of the oldest dividend payers and growers. But this sector ranked the highest in total returns during the same period. The financial and telecom sectors also returned lower total returns despite having high dividend yields.

In order to test this theory I reviewed the ETFs corresponding to the ten S&P sectors. The current dividend yields of the SPDR ETFs for the sectors are noted below:

S.No.S&P SectorETF NameTickerDividend Yield as of Nov 23, 2012
1Consumer DiscretionaryConsumer Discretionary Select Sector SPDR FundXLY1.45%
2Consumer StaplesConsumer Staples Select Sector SPDR FundXLP2.71%
3EnergyEnergy Select Sector SPDR FundXLE1.71%
4FinancialsFinancials Select Sector SPDR FundXLF1.69%
5Health CareHealth Care Select Sector SPDR FundXLV1.95%
6IndustrialsIndustrials Select Sector SPDR FundXLI2.20%
7Information TechnologyTechnology Select Sector SPDR FundXLK2.15%
8Telecommunication ServicesTechnology Select Sector SPDR FundXLK2.15%
9MaterialsMaterials Select Sector SPDR FundXLB2.08%
10UtilitiesUtilities Select Sector SPDR FundXLU3.60%

Note: The SPDR Technology Select Sector ETF includes represents both the S&P Information Technology and Telecommunication Services sectors.

Source: SPDR

The SPDR Utilities Select Sector ETF (XLU) has the highest dividend yield at 3.60% and the Consumer Staples ETF(XLP) has a yield of 2.71%.

In terms of returns, the 5-year return for XLP is 7.96% while the XLU grew by just 2.15%. For the 10-year period, XLU was up by 10.94% and XLP was up 8.55%.

The following chart shows the 5-year price return of the utilities and consumer staples sector ETFs:

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The utilities sector ETF severely lagged the performance of the consumer staples sector ETF. If dividends were added and total returns calculated the variance would be even higher.

The following chart shows the price return of the utilities and consumer staples sector ETFs since 1999:

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Source: Google Finance

In the long-term also, the utilities sector ETF’s return was lower than that of the consumer staples sector ETF’s return.

At the individual stock level,a $10,000 investment in Exelon Corp (EXC), a randomly electric utility, would be worth $4,602 now. However the same investment in two consumer staple stocks Procter & Gamble Co(PG) and Colgate-Palmolive Co(CL) would be worth $10,609 and $15,104 respectively. Hence investors may want to avoid picking stocks purely on high dividend yields and instead focus on long-term total returns.
Disclosure: No Positions

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