Yes, the answer is dividends. Almost always.

More and more evidence is showing that dividends are important, providing the bulk of equity investor returns for many generations. This doesn't mean it's always a good time to buy dividend stocks, but it's something to keep in mind.

Bebeto Matthews/AP
Traders work as the New York Stock Exchange nears closing in this July 2012 file photo. Something to remember: while buying dividend stocks is not always the right answer, they're looking more and more favorable in the current market climate.

The evidence that dividends are hugely important just continues to pile up. By saying this, I don't mean that it is always a good time to buy dividend stocks - right now, for example, the utility sector looks particularly stupid trading at a premium multiple to the market...but I digress.

Ben Inker of GMO took on Bill Gross's Death of the Cult of Equities spiel in a new white paper yesterday.  Essentially, he proves the point that GDP growth rates have little or nothing to do with stock market returns here or elsewhere in the world, effectively negating Gross's premise that some sort of mean reversion must take place.  And while that's all well and good, I think the more interesting portion of Inker's white paper dealt with enormous contribution of dividends for the total return of stocks over the decades.  Check this out:

When we look at stock market returns, dividends have a very large impact on the total, providing the bulk of equity investor returns for most of history. Exhibit 5 shows the compound growth of real returns and real earnings per share against real GDP. Unlike aggregate profits and market capitalization, it is fairly clear that neither returns nor EPS grow in line with GDP.

The gap between the 1.7% real earnings growth (about half the rate of GDP growth) and 5.9% real return (almost double the rate of GDP growth) is made up by dividends, which have averaged about 3.9% since 1929, and a bit of valuation shift (the P/E of the market is a couple of points higher today than it was in December of 1929). 

At my shop, we've been emphasizing fundamentally-weighted indices based on dividends since way before it was fashionable.  And while, in the short-term, the trade has gotten a bit crowded, we'd love nothing more than the opportunity to buy weakness as fairweather investors run and chase the next shiny object that comes along in the near future.

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