Dividends vs. Buybacks: Why Goldman Sachs Predicts a Banner Year of Dividend Growth

A fierce debate has been raging over the effectiveness of share buybacks over dividends in terms of realizing strong gains. The reality is they work in concert to provide a good total return. But that doesn’t mean there can’t be periods where one form of shareholder rewards works better. For Goldman Sachs, 2023 could be the year of dividend growth.

That’s the gist of a new research note published in April from the investment bank. According to the bank, stocks that prioritize their payouts and growing those dividends will do better than those that focus on buying back stock. The reason comes down to the macro-economic environment, earnings, and cash flows/balance sheet strength.

It’s no secret that the economic picture in the U.S. is getting a bit hazier, while rising rates have curtailed spending. That plays a part in how firms distribute excess cash to shareholders. Already, reported earnings for the fourth quarter of 2022 and first quarter of 2023 have shown that cash flow growth has slowed, while cash balances on average have decreased. With economic conditions becoming mixed, firms have a penchant for strengthening balance sheets.

This affects shareholder rewards. Dividends are sort of set in stone and most firms will not try to cut or suspend them unless they have to. In addition, dividends are paid out in installments. This requires less cash on hand or allows firms to still hold cash on their balance sheets. However, buybacks tend to be large sums of money at once. For a buyback to be effective, a company needs to buy a bunch each quarter, often much more outlay that it would to pay a dividend.

According to Goldman, the switch is already on. Looking at dividend and buyback data, for Q1 of 2023, dividends paid by companies in the S&P 500 grew by 8% year over year. However, buybacks have started to slide. First quarter data isn’t available yet, but the number of buybacks fell by 11% in Q3 of 2022 and by 21% in Q4.

To quote the report, “The difference in outlooks for dividend and buyback growth suggests firms focusing on dividends will continue to outperform buyback stocks.”

When looking at returns for those stocks focused on dividend growth vs. buyback growth, Goldman’s viewpoint is supported.

Looking at the Nasdaq U.S. Broad Dividend Achievers Index and NASDAQ U.S. BuyBack Achievers Index, the dividend payers have outperformed since the end of the third quarter last year. This chart highlights the difference. Just focusing on this year has shown a similar result, with dividend payers providing a positive return, while buyback-heavy stocks have trended sideways and down.

 

Source: StockCharts.com

With Goldman predicting more buyback cuts, but dividend growth to average 5% for the rest of the year, the potential for continued outperformance is there.

Given the potential for dividends to outperform, investors may want to focus their portfolios in this area. There are numerous ETFs that cover the space, with the iShares Core Dividend Growth ETF, ProShares S&P 500 Dividend Aristocrats, Vanguard Dividend Appreciation ETF, and Invesco Dividend Achievers ETF being four low-cost passive ETFs focused on dividend growth.

Another choice? Go active. With active management, investors can find higher rates of dividend growth, strong initial yields or top/better performing sectors. You can certainly run our screener to find top stocks that fit your criteria. Or let a professional do it. Both the T. Rowe Price Dividend Growth and Fidelity Dividend Growth offer strong management, low costs, and long-term sector-beating returns. Goldman’s own GS Rising Dividend Growth Fund could also be a strong bet on dividend growth, expanding the theme to include MLPs, REITs, and other ‘non-stock’ stocks.

Don’t forget to check out all dividend-focused mutual funds and ETFs here.

The current economic environment favors dividend growth over buyback-focused stocks. Goldman Sachs lays out the case given the higher cash outlays needed for buybacks and over dwindling conditions. With that, investors may want to tilt their portfolios toward dividends this year. Either through ETFs, individual stocks or active mutual funds, adding a dose of dividend growth is easy.