Learn about dividend futures and how they offer a unique opportunity to profit from dividend growth without owning stocks. Explore the potential benefits, execution process, and risks associated with dividend futures trading.
Troy D. Hanson
November 08, 2023
Dividend stocks have had their fair share of struggles this year, and dividend growth exchange-traded funds (ETFs) have failed to outperform the iconic S&P 500 index. However, what if there was a way to tap into the potential of dividend growth without actually owning the stocks themselves?
Believe it or not, this isn't just a hypothetical question. Thanks to the fascinating world of dividend futures, investors now have the opportunity to take a position on the amount of dividends disbursed by a specific company, exchange, or index at a given maturity date. For instance, those interested in the S&P 500 can purchase a futures contract that expires towards the end of a particular year, granting them a payment equivalent to the index's per-share dividend value - which stood at around $68 in 2022.
Futures contracts are essentially agreements to buy or sell assets at a predetermined price and time in the future. While farmers rely on them to manage risk, traders often utilize futures as vehicles for speculation. In the case of dividend futures, each contract holds a value that is 250 times greater than the estimated worth of the dividends paid once the contract concludes. To put things into perspective, acquiring a dividend futures contract priced at $69 would cost investors approximately $17,000.
While this may sound like an esoteric venture, executing dividend futures trades is relatively straightforward. Popular brokers such as Charles Schwab, E*Trade, Interactive Brokers, and NinjaTrader offer futures trading opportunities, albeit with some additional paperwork to complete.
The potential benefits make this endeavor well worth considering. At present, one could potentially earn an impressive 8% annual return by solely betting on dividend growth. The 2023 S&P 500 contract currently hovers around $68.70. With just over a month remaining until maturity on December 15th, esteemed Goldman Sachs Chief U.S. Equity Strategist, David Kostin, estimates that the per-share dividends will rise to about $70 in 2023. This means that investors stand to gain approximately $1.30 by the contract's conclusion, or a 1.9% increase. Annualized, this equates to around a 17% gain - assuming Kostin's projections hold true.
A Promising Future for Dividends
Investors looking for long-term growth in dividends may find the futures market to be a lucrative option. According to Goldman Sachs strategist David Kostin, the futures market indicates minimal dividend growth in the near future, but Kostin disagrees with this notion. He predicts a 5% annual increase in dividends over the next few years. This projection suggests that by 2026, the S&P 500 per share dividends, currently priced at $65, could reach approximately $82. This potential return of 26% within three years equates to an average annual return of about 8%.
However, it is important to consider the risks associated with investing in dividend futures. The value of these contracts fluctuates, meaning that while they can appreciate, they can also depreciate. Investors must be prepared to weather this volatility and hold their positions until maturity to fully benefit from this trade opportunity. Additionally, there is always the possibility that dividends may not experience the anticipated growth, resulting in investors obtaining no returns or even suffering losses.
Kostin has found that earnings growth is a reliable predictor of dividend increases. Although 2023 has seen weak earnings growth, with a meager 1% increase in the overall S&P 500, FactSet estimates suggest a return to stronger growth in 2024. This anticipated growth is likely to contribute positively to dividend growth as well. Kostin writes, "We forecast 10-year annualized dividend per share growth will equal 5%."
This forecast seems quite reasonable considering historical data. Over the past decade, S&P 500 earnings have grown at an average annual rate of approximately 8%, while dividends have experienced an average annual growth rate of about 7%. It is worth noting that even during the financial crisis from 2007 to 2010, the worst three-year per share decline in dividends for the S&P 500 was only around 20%.
For those who prefer not to engage in futures trading, an alternative option is to invest in dividend growth ETFs. These ETFs allow investors to bet on higher-than-expected dividend payouts. Two popular options are the Vanguard Dividend Appreciation ETF (ticker: VIG) and the iShares Core Dividend Growth ETF (DGRO). VIG, with assets totaling $80 billion, currently yields 2% and has provided a return of 5.5% in 2023, while DGRO, with $25 billion in assets, yields 2.7% and has generated a return of 1.6% this year.
Although not as direct as dividend futures, these ETFs offer simplicity and potential long-term returns for investors seeking to capitalize on dividend growth.