November 9, 2005

The S&P High Yield Dividend Aristocrats Index

Srikant Dash Since 1926 dividends have contributed nearly a third of total
srikant_dash@sandp.com equity return, while capital gains have contributed two-thirds.
1 (212) 438-3012 Therefore, sustainable dividend income and capital appreciation
potential are both important to total return expectations.
Managers use stable and increasing dividends as a signal of
confidence in their firms prospects, while investors consider such
track records a sign of corporate maturity and strength.
The S&P High Yield Dividend Aristocrats index is designed to
measure the performance of the 50 highest dividend-yielding U.S.
Dividend Aristocrats. U.S. Dividend Aristocrats are those S&P
Composite 1500 constituent stocks that have followed a
managed-dividends policy of consistently increasing dividends
every year for at least 25 years.
The index is broadly diversified across sectors. This contrasts
with other dividend indexes, which are concentrated in Financials
and Utilities, and are therefore more vulnerable to sector-specific
and interest-rate risk.
The quality of the Aristocrats index portfolio is also superior. The
Aristocrats have higher returns on equity, higher quality ranks
and higher credit ratings.
The Aristocrats index has had higher risk-adjusted returns than
the S&P 500, the S&P 500 Equal Weight and other dividend
indexes over the past five years. It has also consistently delivered
yields in the range of 3.2% to 4.2%.
The index is weighted by indicated yield. It incorporates
minimum market capitalization and liquidity screens, as well as
buffer zones to reduce turnover at rebalancings.

www.dividendaristocrats.standardandpoors.com
S&P High Yield Dividend Aristocrats

Dividend Aristocrats
Dividend growth has been intricately linked to equity valuation since John Burr
Williams Dividend Discount Model of the late 1930s. Managers use stable and
increasing dividends as a signal of their confidence in a firms prospects. Investors
consider such track records a sign of corporate maturity and strength.

Standard & Poors has been identifying stocks with a long history of consistent dividend
increases (which it terms Dividend Aristocrats) since the early 1970s. The S&P High
Yield Dividend Aristocrats index (hereafter referred to as Aristocrats for brevity) is an
index of stocks that follow such a managed-dividend policy. The stocks in the list must
satisfy the following criteria:
Be a member of the S&P Composite 1500 index.
Have increased dividends every year for at least 25 consecutive years.
The index is weighted by indicated yield. It incorporates minimum market capitalization
and liquidity screens, as well as buffers to reduce turnover at rebalancings. There are
also concentration limits to prevent any stock from being more than 4% of the indexs
total weight at rebalancing.1
The criterion of 25 years of dividend increases is very selective. This selectivity results
in less than 2% of U.S. listed companies qualifying as Aristocrats, as shown in Exhibit
1. As Exhibit 2 shows, the criteria ensure that Aristocrats have not only survived and
paid dividends, but also increased their dividends regularly through business cycles
affecting their specific industry as well as the broader economy.

Exhibit 1: Aristocrats universe Exhibit 2: Selectivity of Aristocrats criteria

U.S. listed companies
6000+ 25

20
S&P 1500 - Investable, liquid
companies accounting for around
90% of market cap of universe
1500 15
25
10 20

S&P 1500 companies that paid

dividend every year for 25 years 5
423

0
U.S. Dividend Aristocrats Minimum number of Median age, in years, of a
85 annual dividend increases S&P 1500 company
required to be a member of
Dividend Aristocrats
Source: Standard & Poors. Counts as of December 2004, age as of September 2005.

1
See S&P High Yield Dividend Aristocrats Methodology at www.dividendaristocrats.standardandpoors.com.
Standard & Poors maintains a series of Dividend Aristocrat indexes, including the S&P 500 Dividend Aristocrats.

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S&P High Yield Dividend Aristocrats

Why Care about Dividends?

Dividends are an important and growing portion of personal income

In 2004 dividend income comprised 4.6% of per capita personal income in the U.S.,
compared to 2.7% 20 years earlier. In terms of year 2000 dollars, total personal dividend
income increased from $134 billion to $407 billion. During the same period, the other
source of income from capital markets, interest, saw its share in personal income shrink
from 15.7% to 9.8%. Exhibits 1 and 2 chart the growing importance of dividend income
vis--vis interest income. As equity ownership becomes even more ubiquitous, and a
growing number of retiring Americans seek income-generating assets, the importance of
personal dividend income shall increase.
Exhibit 3: Dividend and Interest Income as a % of U.S. Personal Income

16%

14%

12%

10%

8%

6%

4%

2%

0%
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Dividend Income as % of Total Personal Income
Interest Income as % of Total Personal Income
Exhibit 4: U.S. Personal Dividend and Interest Income
(in terms of year 2000 dollars)

1,000
900
800
Billions of dollars

700
600
500
400
300
200
100
-
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004

Personal dividend income (in 2000 dollars)

Personal interest income (in 2000 dollars)

Source: U.S. Department of Commerce, National Economic Accounts.

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S&P High Yield Dividend Aristocrats

Dividends contribute to a third of long-term total returns from equity

Dividend income comprises a big slice of total returns from equity. Exhibit 3 plots the
contribution of dividends to the average monthly total return of the S&P 500 through
several decades. 2 From 1926 to 2004 dividends comprised 34% of the monthly total
return of the S&P 500.
Exhibit 5: Dividend Income as a % of
Monthly Total Return of the S&P 500
60% 53%
50%
50%
39%
40% 34%
28% 26%
30%

20% 14%

10%

0%
1940's 1950's 1960's 1970's 1980's 1990's 1926 to
2004
Source: Standard & Poors

The compounding effect of dividend income

The compounding effect of the seemingly small dividend income is dramatic,
particularly as the investment horizon is extended. Exhibit 4 plots this compounding
effect for the S&P 500 over several time horizons. The plotted figures are averages for
every continuous investment horizon over each time period, based on monthly data for
the 50 years ending 2004. Exhibit 5 plots the growth of $1 invested in the S&P 500 with
and without dividend reinvestment from 1930 to 2004. The differences are stark to say
the least.
Exhibit 6: The Compunding Effect of Dividend Reinvestment
1000%
905%
900%
800%
700%
600%
Returns

500%
382%
400%
300% 245%

200% 142%
46% 61% 91%
100% 10%14% 32%
0%
1 Year 3 Years 5 Years 10 Years 20 Years
S&P 500 Price Return S&P 500 Dividend Reinvested Total Return

Source: Standard & Poors

2
The S&P 500 did not actually have 500 stocks prior to 1957, and was known as the S&P Composite Index. However,
for simplicitys sake we use the term S&P 500 throughout this paper.
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S&P High Yield Dividend Aristocrats

Exhibit 7: Cumulative Return of $1 invested in S&P 500

$10,000
$1,353
$1,000
$57
$100

In vestment Valu e($) $10

$1

$0

$0
Dec-29

Dec-34

Dec-39

Dec-44

Dec-49

Dec-54

Dec-59

Dec-64

Dec-69

Dec-74

Dec-79

Dec-84

Dec-89

Dec-94

Dec-99

Dec-04
S&P 500 Price Return Only S&P 500 Dividend Reinvested Total Return

Source: Standard & Poors. Cumulative returns from December 31, 1929 to September 30, 2005.

Dividends cushion equity downturns

While price returns can be either positive or negative, dividend incomes are by
definition positive. This provides a cushion during negative markets. Exhibit 6 plots
annual price return and dividend income during positive return and negative return
years, from 1926 to 2004.

Exhibit 8: Dividend Cushion in Down Markets

Average Price Return Average Dividend Income

25%
19%
20%
Average Annual Return

15%
10%
5% 4%
5%
0%
-5%
-10%
-15%
-15%
-20%
Up Market Years Down Market Years

Source: Standard & Poors

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S&P High Yield Dividend Aristocrats

Dividends and Sector Diversification

The hidden risk of high-yield portfolios

While equity investors are increasingly recognizing the value of dividend income, the
sector risk associated with dividend-oriented portfolios is often ignored. Typically, most
dividend-oriented portfolios or index funds are dominated by two sectors, Financials
and Utilities. For example, the Dow Jones Select Dividend Index and the Mergent
Dividend Achievers 50 Index have nearly 60% and 80%, respectively, in these two
sectors. This is because companies in these sectors have traditionally been the biggest
dividend payers, and portfolios focused exclusively on high yields tend to be
concentrated in these sectors. While this approach enhances current yield, it poses
significant sector risks. Traditionally, Financials and Utilities have done well in stable
and low interest rate environments. However, both sectors have suffered in high rate
environments. This is shown in Exhibit 9, which plots the returns for the two sectors in
different rate environments. (Rising rate environments are defined as quarters in which
federal funds increased by 25 bps or more, falling rate environments as those where
rates fell by 25 bps or more, and stable rate environments as those in which rates
changed by less than 25 bps.)

Exhibit 9: Portfolios concentrated in Utilities and Financials are

vulnerable to rising rates
25%
21.6%

20%

15%
9.8% 8.5%
8.2%
10%

5% 3.8%

0%
Financials Utilities
-1.9%
-5%
Rising Rates Falling Rates Stable Rates

Source: Standard & Poors. GICS based sector sub-indices of the S&P 500 used to represent
sector returns. Returns are annualized averages, based on quarterly observations from 4th quarter
1989 to 3rd quarter 2005.

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S&P High Yield Dividend Aristocrats

Aristocrats are sector-diversified

The Aristocrats portfolio is more sector-diversified, compared to other dividend yield-
oriented portfolios and indexes. This is because the criterion of increasing dividends
every year for 25 years brings in companies from a broad spectrum of industries. This is
shown in Exhibit 10, which shows the sector distribution of the Aristocrats, the Dow
Jones Select Dividend Index and the Mergent Dividend Achievers 50 Index.

Exhibit 10: Aristocrats have better sector diversification

(and much less exposure to rate sensitive utilities and financials)
100%

90%

80%

70% Telecom
32%
Materials
60%
Industrials
50% 22% Health Care

40%
Energy
20% Consumer Staples
30%
52% Consumer Discretionary
20% 38% Utilities
26% Financials
10%

0%
Dow Jones Select Mergent Dividend S&P High Yield
Dividend Achievers 50 Dividend
Aristocrats

Source: Standard & Poors, www.ishares.com, www.powershares.com. GICS classification used.

The S&P High Yield Dividend Aristocrats and Dow Jones Select Dividend compositions are as
of September 30, 2005. Mergent Dividend Achievers 50 composition is as of July 31, 2005.

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S&P High Yield Dividend Aristocrats

Quality of Dividends

Decomposing total returns

As noted before, dividends have historically contributed a third of equity returns, while
another two-thirds have come from capital appreciation. This suggests that dividend
income and capital appreciation are both important for total return expectations.
However, dividend yield is inversely proportional to current price. This makes the two
components of the total return slightly counter to each other. For example, a low stock
price might be attractive from the dividend yield perspective, but it may signal a lack of
capital appreciation potential.

Total Returns = Dividend Yield + Capital Appreciation

(100%) (34%) (66%)

Inversely proportional to current price Proportional to future price

Constituent quality
Given this framework, investors need to balance current yields with future capital
appreciation potential to meet their total return expectations. Not only should the current
dividends be sustainable, but current yields should also not be a signal of future lack of
price appreciation. This makes the quality of the underlying portfolio important.

Exhibits 11 through 13 compare the Aristocrats portfolio with the Dow Jones Select
Dividend and Mergent Dividend Achiever 50 portfolios, across parameters such as
return on equity, credit quality and quality rankings. The Aristocrats portfolio has better
quality characteristics than the other two portfolios, suggesting that it better balances
capital appreciation potential with high current income.
Exhibit 11: Aristocrats have higher return on equity
18 %

16 % 15%
14%
14 %
12%
12 %

10 %
8%
6%
4%
2%
0%
S&P High Yield Dividend Dow Jones Select Mergent Dividend
Aristocrats Dividend Achievers 50

Source: Standard & Poors, www.ishares.com, www.powershares.com. Median of portfolio.

S&P High Yield Dividend Aristocrats and Dow Jones Select Dividend compositions are as of
September 30, 2005. Mergent Dividend Achievers 50 composition is as of July 31, 2005.

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S&P High Yield Dividend Aristocrats

Exhibit 12: Aristocrats have superior credit ratings

70%
62%
Investment Grade Junk
60%

50% 48%
% of constituents 44%

40%
31% 32% 30%
30%

20% 18%

10% 11%
10% 6% 6%
2%
0%
A or higher BBB to A- BBB- or Lower Not Rated
S&P High Yield Dividend Aristocrats Dow Jones Select Dividend Mergent Dividend Achievers 50

Source: Standard & Poors, www.ishares.com, www.powershares.com. S&P High Yield

Dividend Aristocrats and Dow Jones Select Dividend compositions are as of September 30,
2005. Mergent Dividend Achievers 50 composition is as of July 31, 2005.

Exhibit 13: Aristocrats have better quality ranks

70%
64%
60%
60%

50% 47%
% of constituents

40% 36%
32%
30%
30%
21%
20%

10%
4% 4%
2%
0%
Above Average (A- or Average (B+) Below Average (B or Not Ranked
higher) lower)
S&P High Yield Dividend Aristocrats Dow Jones Select Dividend Mergent Dividend Achievers 50

Source: Standard & Poors, www.ishares.com, www.powershares.com. S&P High Yield

Dividend Aristocrats and Dow Jones Select Dividend compositions are as of September 30,
2005. Mergent Dividend Achievers 50 composition is as of July 31, 2005.

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S&P High Yield Dividend Aristocrats

Historical Return and Yield Characteristics

Consistently high yields

The Aristocrats index has consistently delivered yields in the range of 3.2% to 4.2%
over the last five years. This is shown in Exhibit 14.

Exhibit 14: S&P High Yield Dividend Aristocrats Index has

delivered consistently high yields
5.0

4.0
Yield (in %)

3.0

2.0

1.0

0.0
Dec-99

Jun-00

Dec-00

Jun-01

Dec-01

Jun-02

Dec-02

Jun-03

Dec-03

Jun-04

Dec-04

Jun-05

Dec-05
Historical Outperformance
As Exhibit 15 shows, the index has had higher risk-adjusted returns than the S&P 500,
the S&P 500 Equal Weight Index (EWI) and other dividend indices over the past five
years. (The history of the index goes back only to December 1999.) On an absolute
return basis, it has outperformed the S&P 500, S&P EWI and Mergent Dividend
Achievers 50 index, and its risk has also been consistently lower.

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S&P High Yield Dividend Aristocrats

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S&P High Yield Dividend Aristocrats

For more information, go to www.dividendaristocrats.standardandpoors.com

Disclaimer

This report is published by Standard & Poors, 55 Water Street, New York, NY 10041. Copyright
2005. Standard & Poors (S&P) is a division of The McGraw-Hill Companies, Inc. All rights
reserved. Standard & Poors does not undertake to advise of changes in the information in this
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Dividend Aristocrats Index, any data included therein, or any data from which it is based, and
Standard & Poors shall have no liability for any errors, omissions, or interruptions therein.
Standard & Poors makes no warranty, express or implied, as to results to be obtained from the use
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Standard & Poors does not sponsor, endorse, sell, or promote any investment fund or other
vehicle that is offered by third parties and that seeks to provide an investment return based on the
returns of the S&P High Yield Dividend Aristocrats Index. A decision to invest in any such
investment fund or other vehicle should not be made in reliance on any of the statements set forth
in this document. Prospective investors are advised to make an investment in any such fund or
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