We think it s a good time to revisit the benefits of
long-term dividend compounding.


While big rallies grab headlines, equity markets spend a lot of time trading sideways, highlighting the importance of being paid to wait. With overseas markets consolidating 2009 s sharp gains, it s understandable that investors closely track overseas equity price movements. Our analysis indicates they should be just as focused on dividend growth and sustainability, in addition to making sure they are regularly reinvesting the proceeds.
It s no secret that international equities generally sport slightly higher yields than their domestic counterparts. The S&P Global ex-U.S. index, which includes both developed and emerging market (EM) overseas exposure, recently yielded 2.5% compared to the S&P 500 s smaller 2%. However, the degree to which dividend compounding can increase long-term overseas returns remains underappreciated, in our view.
Consider this: From December 31, 1969 through the end of 2009, the MSCI EAFE index, a developed international benchmark, produced a compounded total return (includes reinvested dividends) of 4,729% versus 1,481% in price appreciation alone. When we analyze the key regional components that make up the developed overseas equity asset class, we see similarly wide performance gaps. Europe did best, increasing 6,016% on a total return basis compared to only 1,342% on a price basis. Canada followed, posting a 5,285% total return versus 1,527% from a price appreciation standpoint. Pacific ex-Japan rose 5,021% on a total return basis in contrast to a 1,078% price gain. Even Japan, a perennially low-yielding market (its recent yield was only 1.6%), registered a total return of 936% versus 468% in price appreciation.
While emerging market equities are better known for their strong price appreciation potential, their long-term total returns have also benefited dramatically from compounding dividends. From December 1987 through the end of 2009, the asset class rose 1,630% on a total return basis compared to a price gain of just 889%. This equates to an average annual total return of 20% versus 17% in price appreciation. In general, emerging Asia has historically offered lower yields, while those from emerging Europe, the Middle East&Africa (EMEA), and Latin America have been slightly higher.
In contrast, developed overseas markets annual total returns averaged 13% versus only 9.8% in price gains over the same period. Put another way, dividend compounding has generated 15% of EM average annual total returns against a higher 24.4% of developed overseas average annual total returns. The reason for this is that EM price appreciation has been so much stronger than that of developed markets, resulting in compounded dividends making up a smaller percentage of EM total returns. In addition, EM stocks tend to yield less than those in developed foreign markets. Recently, EM shares yielded 1.8%, while developed foreign markets sported a 2.7% yield. But because developed countries comprise 79% of free-float adjusted international market cap, EM s lower yield is less of a drag on foreign returns overall.
Alec Young

International Equity Strategist

05-Mar-2010 17:00:34 (15194189)   Copyright 2009 The McGraw-Hill Companies, Inc, Standard & Poor's, a division of The McGraw-Hill Companies, Inc., and their affiliates (collectively, "S&P"). Reproduction of this content in any form is prohibited except with the prior written permission of S&P.