Historically, investors have gravitated towards dividend stocks and for good reason. Since 1926, as much as half of investors’ total return from the S&P 500 Index has come from dividends. Those dividend stocks have been nearly twice as profitable as the non-dividend paying stocks.
Dividends increase the likelihood that a company is profitable and generating cash flow to permit the payouts. This provides a quick way to steer clear of potentially unprofitable enterprises.
Dividends can reflect a company’s realization that profits should be shared with a company’s owners, the shareholders. Dividends can serve as a brake on management’s belief that their plans to reinvest earnings will always be profitable.
Dividends can reduce volatility. Amid a market sell off, fixed income investors may gravitate towards solid dividend paying stocks from bonds if the selloff increases the yield sufficiently. Growth investors may rotate into dividend stocks if fears develop of economic weakness or geopolitical stress.
Qualified dividends, which are most dividends save for REITs’, are taxed at substantially lower rates than ordinary income like that from bonds and CDs.
On the other hand, some investors are skeptical of dividend paying stocks. Returning profits to shareholders signals that the company’s prospects of reinvesting the earnings for growth are limited. If you’re looking for a periodic payout, stick with safer bonds. If you’re investing in stocks, you’re looking for growth and capital appreciation. Finally, under some proposals of the presidential candidates, dividends could be taxed at higher rates.
Dividend Stocks Lag Recently
Recently, dividend paying stocks, even stocks with growing dividends, have lagged the market. For the last five years, the S&P 500 High Dividend Index, which tracks the 80 highest S&P 500 yielders, provided a per annum return of 3.1%, versus 9.5% for the S&P 500 itself. Interestingly, up until January 30 of this year they were neck and neck. Since January 30, the S&P 500 has been essentially flat, but its High Dividend cousin has dropped 26%.
How did that happen? With pandemic induced recession, investors became skeptical that dividend payors could continue to pay out, and indeed some payouts have been suspended. Traditional dividend payors, like energy and financials, have had their own special issues. Fossil fuel prices plunged, to below $0 briefly, and have not fully rebounded, as excess supply met with diminished demands due to lockdowns and reduced travel. Meanwhile, financials grappled with reduced lending margins as the Federal Reserve caused benchmark interest rates to fall to near 0%. Lenders also took write downs on the value of the loans on their books.
The S&P has been kept afloat by the outperformance of the mega cap tech stocks. These companies have outsized influence on the index due to its market cap weighted nature, plus their businesses soared as stay at home orders forced people to rely more heavily on digital and electronic tools.
In A Nutshell
Historically, dividends have represented a sizeable proportion of a stockholders’ total return. Further, dividend stocks have historically outperformed the market generally.
However, more recently, as markets have gravitated to companies offering greater growth prospects, dividend paying stocks have lagged. This year has added to the pain for these stocks, as investors have grown more skeptical that dividends can be sustained much less increased amid the coronavirus caused economic downturn.
While the timing is always uncertain, the rationale for the positive performance behind dividend paying stocks remains, and they may again outperform.
Investors may use the list of the “Dividend Aristocrats” as an initial screen for companies that not only pay out dividends but have increased them regularly for decades.
Of course, a company’s dividend history is just that, history, and investors must still try to divine what the future holds. There are no guarantees that focusing on a history of dividend payouts will always be profitable much less allow for outperformance.
No one really knows what the catalyst might be for dividend stocks to again outperform.
All portfolios should be well diversified by sector to reduce volatility.
The Dividend Aristocrats
The Dividend Aristocrats are 65 S&P 500 stocks that not only pay out a dividend but have grown that dividend each year for at least the last 25. Dividend growth is widely viewed as a potentially more profitable investment strategy than simply chasing high but not necessarily growing dividends. The trouble is the tradition of annual dividend raises may not continue. However, you’ve got some sense that the enterprise is growing, and that management sees annual boosts to its payout as an important part of its mission.
Reflecting investors’ preference for not just dividends, but growing dividends, an ETF tracking this index (ProShares S&P 500 Dividend Aristocrats (NOBL)) is down just 6% since January 30, better than the 80 simply high yielders, but still slipping materially below the S&P 500 itself.
Using the Dividend Aristocrats cohort as an initial screen, it’s possible to identify several components, in various industry groups, that have attractive profit potential.
Consumer Staples: Coca Cola (KO):
Consumer staples have historically been great portfolio holdings. They tend to be less cyclical; they are brand name oriented, giving them exceptional resilience. However, the coronavirus downturn and lockdown has hurt those staples stocks that rely on out of home consumption.
Beverages like Coke can be consumed at home or at say the ballpark. The difference is that the profitability of purchases at restaurants or sporting pavilions is much greater than at home.
Coke’s unassailable moat is that they are three times bigger than any other beverage competitor, affording huge economies of scale and allowing them to leverage their ad budget. While soda sales are flat, growth is coming from more trendy offerings like premium water and energy drinks.
At the start of the year, before the Covid downturn, Coke stock was 25% higher than it is now. If it takes three years to bring people back out of the home and for the stock to return to that level, that’s a nice return. Volatility is just half the market’s. Dividends? You bet, at 3.4%, or four times the ten-year Treasury and nearly twice the market’s. That payout has been increased for the last 58 years in a row.
Financials: Aflac (AFL):
Financials have been hit hard by the downturn. With interest rates so low, margins between what is paid out on deposits and what’s earned on loans have collapsed. Skepticism abounds on the value of loan portfolios, as small business struggles amid the coronavirus restrictions. Regulators continue to scrutinize the banks, with new caps on dividend payouts.
Insurance companies seem to have been as unloved as banks, their fellow financials. Although insurance companies suffer through the same low interest rate environment, there is less concern about the quality of the assets on their books. While highly regulated, they are not as tied up as the banks since the 2008 subprime crisis, when banks were particularly hard hit.
Aflac, famous for the quacking duck, is a high-quality insurer marketing supplemental insurance to the non-Medicare crowd. Normally, its yield is under 2% but with the Covid selloff, the stock sits nearly 40% below its early 2020 high.
The stock’s payout is now 3.1%. It can increase it easily, as it constitutes just a quarter of its earnings. The dividend has been hiked 37 years in a row. There’s also a big stock buyback program.
New products and additional growth may stem from Aflac’s recent investment in pet insurance company Trupanion. Maybe even the duck will get its own insurance.
Real Estate: Essex Property Trust (ESS):
Real estate has been hit hard in this recession. Other than single family homes, storage for companies preparing to ship online purchases, and sites for new 5G towers, investors have little faith in this sector.
After all, why invest in landlords after the government says you won’t be evicted if you don’t pay your rent? However, high quality apartment owners like Essex have been punished too much. The stock is down 40% since February. It is unlikely that landlords are cutting rents by that much or that so many are failing to pay rent.
Essex owns 250 apartment complexes with over 60,000 units in prestigious areas up and down the West Coast. Rising construction costs means duplicating these properties is increasingly expensive. Millennials are pushing back against settling down. No matter the state of the virus, you need some roof over your head.
We like Essex’ dividend record. It’s hiked the payout for 26 years in a row, with a ten-year growth rate of 6.5% and current yield of 4.1%. As a real estate investment trust (REIT), it’s exempt from corporate taxes. Higher corporate taxes shouldn’t affect REITs, adding to their allure.
Dividend paying stocks have been left behind in this year’s market recovery from the coronavirus triggered market low in March. A catch up in performance is likely, although the timing is unclear. Using a prescreened list like the S&P Dividend Aristocrats allows you to focus on those companies that have a very long track record of not only paying dividends but growing them.
Note: David Dietze is President and Chief Investment Strategist at Point View Wealth Management.
Point View Wealth Management is an SEC-registered investment adviser and part of Peapack Private Wealth Management. For over 25 years, Point View Wealth Management has been providing customized portfolio management services and comprehensive financial planning solutions for individuals and their families to develop and achieve their financial goals.
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