Somewhere along the yield curve, with rates lingering barely above zero, the dividend calculus got more complicated.
Utilities and REITs are no longer the easy favorites as investors starved for income bid up prices. In their place, dividend investors are turning to sectors such as health care, technology and financial services where the earnings prospects seem strong and the Fed seems distant. The new equation combines the search for competitive dividend yield with an emphasis on superior dividend growth.
Dividend investing attempts to capture returns from profits (as paid through dividends) as well as stock price appreciation (as share prices rise). The chart below illustrates how the return (the aggregate result of dividend and stock-price appreciation) was twice as great among stocks of companies initiating or growing dividends as it was among companies paying none. Even compared with the market broadly, returns for companies initiating or growing dividends were nearly one third higher.
For illustrative purposes only. Past performance does not guarantee future results.
In today’s market, some of the most interesting dividend opportunities are among technology, health care and financial firms where expectations are for earnings and dividends to rise. Unlike certain “bond market proxies” – companies like consumer staples, utilities and REITs – they may be less affected by the gradual rate hikes the Fed seems to have in mind.
Many people don’t know it, but tech companies account for nearly 15% of total dividend payouts for the S&P 500 Index. That’s the single largest sector contribution among the 10 broad sectors; and it’s triple what tech stocks delivered a decade ago, according to S&P Dow Jones Indices. For investors focused on dividends in tech companies, one cue could be cash. Cash represents as much as 25% of the valuation of some tech stocks. For investors, that cash might indicate significant potential for growth in dividend and growth in general.
In health care, ongoing consolidation is putting more market share in the hands of a few strong players. The stocks to look for are the quality companies providing value-added services in an expanding segment of the economy. They are the ones with strong potential for growth in earnings and thus dividends.
The financial sector is another area where dividend prospects have been improving as the turmoil of the 2007-2008 crisis recedes. After years of adjusting balance sheets to improve capital ratios, many financial firms are, in fact, becoming safer than ever. Yet market perceptions continue to lag. That means there are a number of possibilities in the financial world among companies raising or restoring dividends to find potential opportunities for dividend yield along with stock-price appreciation.
One more thing to think about. Investing in companies inclined to increase their dividends can afford a sort of resiliency that investing for growth alone may not. The reason is simple: dividend income can provide investors with a return even through down markets.
It’s fashionable in the market to focus on growth. Yet so many of the new economy luminaries don’t pay a dividend – not yet anyway. No matter. Whether it’s caring for people or helping them communicate, there’s nothing old-fashioned about total returns that top the market. Focus on quality businesses capable of sustaining and growing earnings – and dividends.
This is a guest post from Tony DeSpirito and the team at the BlackRock Equity Dividend fund, where Tony is a portfolio manager.