Dividend Risk
Premium

The Dividend Risk Premium is what investors demand to compensate
them for the risk of actual dividends coming short of market expectations.
Like a risk premium, the Dividend Risk Premium indicates that investing
in a dividend strip comes with certain risks, but it also has the potential
for rewards.

Historically, forward dividend expectations of the S&P 500 index (the dividend futures price) have been substantially lower than the realized dividend (the settlement value of the dividend futures contract).

For example, as of December 2015, based on the dividend futures price, the implied 1-year and 3-year dividend growth was 3.76% and 6.77%, respectively.

However, the actual 1-year dividend growth in 2016 was 4.92%, while the S&P 500 dividend grew 25.1% from 2015 to 2018. The discount between implied and realized dividends translates to investment returns on dividend futures contracts.

The table above shows the cumulative and annualized return when investing in the N−period dividend futures at the end of 2015. The annualized return is referred to as the realized dividend risk premium.

On a forward-looking basis, the dividend risk premium can be measured using the difference between dividend futures prices and analyst dividend forecasts.

As of 9/30/2022, equity analysts expect the S&P 500 index to grow its dividend by 4.4% annually for the next several years, while the current futures market implies a -0.9% dividend growth per year till 2030.

The disagreement between the futures price and consensus estimates indicates that investors can take advantage of a decent risk premium to enhance investment return-potential.