The Little-Known Secret to Beating the S&P 500

The old adage “If you can’t beat them, join them” is great for investors to take to heart. If you can’t beat the S&P 500 by picking individual stocks, owning an S&P 500 index fund and at least earning market returns is a smart move.

However, what if I told you there’s a tried-and-true method of beating the market? That strategy is investing in dividend stocks. Not just any dividend-paying stocks, mind you, but those that can grow their dividend payments consistently. That combination of a rising dividend income stream and price appreciation from earnings growth has historically yielded market-beating total returns.

The data on dividend stocks

Hartford Funds and Ned Davis Research have been tracking the average annual total returns of companies in the S&P 500 by dividend policy. Here’s a look at the returns and beta (a key metric measuring a stock’s volatility compared to the broader market) of companies by their dividend policies over the last 50 years. 

Data source: Ned Davis Research and Hartford Funds. Note: Returns data from 1973-2022.

As that table showcases, companies that pay dividends have produced market-beating total returns over the last 50 years. However, dividend growers and initiators drove those returns as they outperformed companies with no change to their dividend policies and those that cut or eliminated their dividends. Meanwhile, dividend initiators and growers absolutely pulverized stocks that don’t pay dividends.

Even better, dividend growth stocks delivered higher returns with less volatility than the broader market. And their volatility is significantly less than that of stingy non-dividend payers.

This outperformance really adds up over the decades. Hartford Funds and Ned Davis Research noted that a $100 investment in an equal-weighted S&P 500 index would have grown into over $4,000 over the last 50 years. However, that same amount invested in dividend growth stocks would have grown to over $13,000 over that period.

A look at some top dividend growth stocks

Many companies have excellent track records of growing their dividends. The best of the best are Dividend Kings, companies with 50 or more years of steady annual dividend growth. Three of the most well-known among this dividend royalty are Coca-Cola (KO 1.93%), Procter & Gamble (PG 1.78%), and Johnson & Johnson (JNJ 1.57%). Coca-Cola and Johnson & Johnson notched their 61st straight years of dividend growth in 2023, while Procter & Gamble is up to 67 consecutive years.

Unsurprisingly, the trio’s steadily growing dividend payments have enabled them to produce market-beating total returns over the past few decades.

^SPX data by YCharts

While that past success is no guarantee of future results, all three appear poised to continue growing their dividends in the coming years.

Coca-Cola’s long-term target is to grow its earnings per share by about 7% to 9% per year. It aims to achieve that by increasing its volumes, improving margins, making growth-related capital investments and consumer-centric acquisitions as opportunities arise, and reducing its outstanding shares by repurchasing stock. Coca-Cola’s growing earnings should enable it to continue increasing its dividend.

Johnson & Johnson invests billions of dollars each year in research and development to grow its earnings. It also makes strategic acquisitions to accelerate its growth, like last year’s $16.6 billion deal for Abiomed to bolster its high-growth Med-Tech division. Add in its fortress-like balance sheet (Johnson & Johnson has an elite AAA bond rating), and it should be able to continue increasing its dividend. 

Procter & Gamble generates mammoth cash flows, giving it the money to reinvest in growing the business, pay dividends, and repurchase shares. These drivers enable the company to steadily increase its earnings per share, allowing it to continue pushing the dividend higher.

Dividend growth stocks yield the highest returns

The data is rather eye-opening. Companies that steadily increase their dividends have historically outperformed the market by a considerable margin and with lower volatility. Because of that, investors seeking market-beating returns should consider loading their portfolios with companies with proven track records of increasing their dividends that seem highly likely to continue.

Matthew DiLallo has positions in Johnson & Johnson. The Motley Fool recommends Johnson & Johnson and recommends the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool has a disclosure policy.