Category Archives: Dividends

Dividend Growth Stocks

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Dividend-growth stocks typically exhibit stable earnings, solid fundamentals and strong histories of profit and growth.

Dividend Growth companies are companies that have consistently grown their dividends over the long-term, such as for at least 15 consecutive years. According to ProShares, these companies generally come with attributes of quality that investors have come to expect:

  • Durable competitive advantages, solid fundamentals, and management teams that are committed to returning capital to shareholders.
  • Higher gross and net profit margins than the broader index, with more consistent levels of earnings growth through the market’s ups and downs.
  • Lower levels of debt than companies in the broader market index.

Dividend growers have also demonstrated a history of weathering market turbulence over time. They’ve done so by delivering most of the market’s upside in rising markets with considerably less of the downside in falling ones—a valuable feature in times of uncertainty.

“Dividend growth stocks have outperformed in various market environments,” according to global investment management firm Nuveen. “Dividend growth stocks have provided an attractive combination of earnings and cash flow growth potential, healthy balance sheets and sustainable dividend policies. These stocks have historically offered compelling performance during up markets and provided a buffer during market drawdowns and in volatile environments.”

When the Federal Reserve shifts from an accommodative monetary easing policy to a restrictive monetary policy, there is often an initial period of market volatility and uncertainty.

Dividend growth has been a desirable trait for equities immediately before, during, and after past cycles of less accommodative Fed policy.

Many investing gurus recommend strong dividend payers as the way to weather dual challenges of inflation and recession, noting that the dividend stocks’ income streams are capable of offsetting inflation – even when inflation is running higher than 8%.

“Dividend growth is one of the few things that has kept up with inflation as you go back and look over the decades. So when you go back and you look at the ’70s, ’80s — which is the last time you can actually find any notable inflation — what you see is dividend growth pretty much kept pace with it,” explained Sharon Hill, the co-leader of Vanguard’s Equity Income Fund.

With the three challenges facing investors today—rising interest rates, slowing economic growth and income scarcity–dividend growth stocks could make a better choice for the current economic and market environment.

Source: ProShares, Bloomberg. Data from 12/31/05 to 12/31/21. Past performance does not guarantee future results. Index calculations do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged, and one cannot invest in an index.

High-quality companies that have consistently grown their dividends tend to have stable earnings, solid fundamentals and strong histories of profit and growth. As a result, they have been generally better positioned to weather potentially slowing growth.

References:

  1. https://finance.yahoo.com/news/investing-whiz-sharon-hill-says-155244449.html
  2. https://www.fidelity.com/insights/investing-ideas/10-dividend-growth-stocks
  3. https://www.proshares.com/browse-all-insights/insights/three-reasons-dividend-growth-may-be-the-right-approach
  4. https://www.proshares.com/browse-all-insights/insights/why-dividend-growth-mid-caps-may-belong-in-your-portfolio

Dividend Growth

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“One common trap that dividend investors can fall into is chasing stocks with high yields when they should be buying dividend growth stocks that can promise years of steady income raises.” ~ Dan Burrows, Senior Investing Writer, Kiplinger.com

Over the last few years when non-dividend paying growth stocks were delivering significant double-digit gains in the span of months, it was easy to ignore the benefits of equity income, writes Stephen Dover, CFA, Chief Market Strategist, Franklin Templeton Institute. Today, given rising interest rates, slowing growth and heightened volatility, the role of dividends is changing amid a more challenging environment for multiple expansion.

Over the long-term, dividends have proven to be a significant driver of total return. Over the last 31 years, spanning January 1990 through December 2021, the receipt and reinvestment of dividends accounted for about 50% of the cumulative total return of the S&P 500 Index, according to Franklin Templeton. In addition, dividend growers, proxied by the S&P 500 Quality High Dividend Index, have outperformed their value and growth counterparts over the more than two decades since 1995.

Dividend payouts can act as a useful quality barometer. A solid track record of growing dividends consistently and sustainably over an extended period of time is typically seen as a signal of healthy company fundamentals, astute and efficient capital allocation and a firm commitment to shareholder value.

Dividend payouts are often cut during periods of grave economic stress, particularly in the most vulnerable companies.

  • Dividends offer evidence of financial strength. Historically companies that initiated or increased their dividend have significantly outperformed those that cut or don’t pay a dividend.
  • Often, stocks with the highest dividend yields come from companies whose market prices have fallen, indicating stress.

In the U.S., 242 companies cut or suspended dividends, according to Capital Group. This number of dividend cuts and suspension nearly match the total for the previous 11 years combined.

After historic cuts, some U.S. companies are restoring dividends

Source: Wolfe Research, LLC. Copyright © Wolfe Research, LLC 2021. All rights reserved. Only companies with market cap of at least $250 million included. Reinstated dividends statistic is through 5/31/21.

But the picture is improving. With the rollout of COVID-19 vaccines and the reopening of economies, many U.S. companies have begun to resume payments.

Many investors, when they search for dividend paying stocks, tend to start with companies that pay the highest dividend yields. These companies can be sound investments, but the high yield can also be a warning sign. “Companies that have very high dividends to start may not be able to sustain them,” Joyce Gordon, Capital Group equity portfolio manager, notes. “The high yield may indicate a company is a melting ice cube, and their business is in decline and they’re not reinvesting.”

Gordon says that dividend growing stocks represent a compelling value for investors. “I look for companies that are yielding around 2.5% to 3.0%, and that are growing their dividends and earnings around 10% or 12% a year. Today I am finding a number of companies that meet that criteria across a wide range of sectors and global markets.”

The best dividend stocks – companies that raise their payouts like clockwork decade after decade – can produce superior total returns (price plus dividends) over the long run, even if they sport apparently ho-hum yields to begin with.

Dividend growers are strong companies that are likely to be even stronger in five or 10 years. “I look for a company that can demonstrate the capacity and commitment to raise its dividends over time,” Gordon says. “I look for dividend growth that matches the underlying earnings growth of the company.”

Dividend growers historically have tended to generate greater returns than other dividend strategies, while also keeping up relatively well with the broader market. People assume that growth companies far outpaced dividend paying stocks over the past decade, and that’s true when you look at the highest yielding stocks. But dividend growers did nearly as well as the overall market.

By providing a growing stream of income, dividend growth can be a sign of company executive management’s more rigorous capital allocation process. “Because they are committed to setting aside some proportion of their earnings for investors, they tend to have better discipline and may be less likely to make some ill-advised acquisition,” Gordon says.

Because it is reflective of growing earnings, dividend growth can also offer a measure of resilience against interest rate hikes, Gordon adds.

Reinvested dividends. The power of reinvested dividends

One company that has consistently grown its dividends is McDonald’s. To get a sense of how regularly reinvesting dividend payments can compound over time, consider a hypothetical $100,000 investment in the company for the 20 years from December 31, 2000, through December 31, 2020, with all dividends reinvested.

Sources: Capital Group, FactSet. Growth rate calculations for value of shares from reinvested dividends and dividends paid use the first year’s dividends payment ($676) as a starting value.

Reinvested dividends tend to provide a downside cushion for total returns during periods of modest capital gains. The 2000s—the “lost decade” for stocks—is a crucial case-in-point. While the S&P 500 delivered annualized total returns of -0.95% in the 10 years from January 2000 through December 2009, the figure would have been worse had dividends been removed from the calculation. Annualized price return for the index in the 2000s averaged -2.72% versus dividends, which provided 1.77% annualized return over the 10-year period.

Using the power of the compounding of re-invested dividends is a good way to build real wealth, simply. Albert Einstein has called compound interest the “Eighth Wonder of the World,” since the power of compounding can be a wonder to behold. The magic of compounding, as Ben Franklin famously said, “Money makes money. And the money that money makes, makes money.”

“Compound interest is the Eighth Wonder of the World. He who understands it, earns it. He who doesn’t pays it” ~ Albert Einstein

Compound interest or “interest on interest” is effectively what compound interest is for investors. “Interest on Interest” or “dividends on dividends” is why the compounding effect on dividend reinvestment creates wealth. The longer you reinvest the dividends, the more dividends you receive because you own more shares. And the cycle continues as long as the investor stay invested in the market and reinvests his/her dividends.

S&P 500 Dividend Aristocrats.

The objective is to find companies that are growing their dividends faster than the market average over time. The Dividend Aristocrats are companies in the S&P 500 Index that have raised their payouts for at least 25 consecutive years. This list of the S&P 500’s best dividend stocks is a mix of household names and more obscure firms, but they all play key roles in the American economy. And although they’re scattered across pretty much every sector of the market, they do all share one thing in common: a commitment to reliable and long-term dividend growth.

References:

  1. https://www.capitalgroup.com/advisor/insights/articles/dividend-growth-special-sauce-long-term-investing.html
  2. https://www.franklintempleton.com/articles/strategist-views/the-case-for-dividends
  3. https://www.kiplinger.com/investing/stocks/dividend-stocks/604131/best-dividend-stocks-you-can-count-on-in-2022
  4. https://www.wealthplicity.com/investing-strategy/stocks-and-equities/the-power-of-compounding-dividend/

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.

International Dividend Investing

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U.S. dividend stocks continue to sport relatively low yields compared with other assets, especially as bond yields climb amid the Federal Reserve’s rate-hike.

But, there are alternatives assets to U.S. dividend stocks…international stocks:

  • MSCI Europe index was yielding 3.4%,
  • Japan’s Nikkei 225 index was yielding 2%,
  • MSCI Emerging Markets index was at 3.1%.
  • S&P500 was yielding 1.6%.

“Outside the U.S., there’s more of a culture of returning capital to shareholders through dividends rather than buybacks,” says Julian McManus, a portfolio manager at Janus Henderson Investors.

International stocks offer an higher yield than U.S. equities, though there are risks. Early in the pandemic, for example, dividend cuts went much deeper overseas than they did in the U.S.

Additionally, most countries impose a withholding tax on dividends paid to nonresidents. However, those withholding taxes, in many cases, can be credited against the U.S. shareholder’s U.S. tax liability, according to Robert Willens, a New York–based accounting and tax expert.

Another risk international dividends pose is that they can be more apt to get cut in economic downturns.

U.S. investors face a trade-off when it comes to international dividends: higher yields with higher risk.

References:

  1. Lawrence C. Strauss, Why Income Seekers Should Consider International Stocks, Barron’s, August 5, 2022.
    https://www.barrons.com/articles/international-stocks-income-dividends-yield-51659585601

Qualified Dividends vs. Ordinary Dividends

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The distinction between Qualified and non-Qualified dividends has to do with how you’re taxed on those dividends.

  • Qualified dividends are taxed at 15% for most taxpayers. (It’s zero for single taxpayers with incomes under $40,000 and 20% for single taxpayers with incomes over $441,451.)
  • Ordinary dividends (or “nonqualified dividends”) are taxed at your normal marginal tax rate.

The concept of qualified dividends began with the 2003 tax cuts. Previously, all dividends were taxed at the taxpayer’s normal marginal rate.

The lower qualified rate was designed to fix one of the great unintended consequences of the U.S. tax code. By taxing dividends at a higher rate, the IRS was incentivizing companies not to pay them. Instead, it incentivized them to do stock buybacks (which were untaxed) or simply hoard the cash.

By creating the lower qualified dividend tax rate that was equal to the long-term capital gains tax rate, the tax code instead incentivized companies to reward their long-term shareholders with higher dividends. It also incentivized investors to hold their stocks for longer to collect them.

Qualified Dividends

To be qualified, a dividend must be paid by a U.S. company or a foreign company that trades in the U.S. or has a tax treaty with the U.S. That part is simple enough to understand.

Importance of dividends

From 1871 through 2003, 97% of the total after-inflation accumulation from stocks came from reinvesting dividends. Only 3% came from capital gains.”

To put this into perspective, take a look at the example used by John Bogle, where he writes: “An investment of $10,000 in the S&P 500 Index at its 1926 inception with all dividends reinvested would by the end of September 2007 have grown to approximately $33,100,000 (10.4% compounded). If dividends had not been reinvested, the value of that investment would have been just over $1,200,000 (6.1% compounded)—an amazing gap of $32 million.” The reinvestment of dividends accounted for almost all of the stocks’ long-term total return.

Dividends are an important consideration when investing in the share market as they provide a reliable source of return while you wait.

References:

  1. https://www.kiplinger.com/investing/stocks/dividend-stocks/601396/qualified-dividends-vs-ordinary-dividends

The Power of Dividends

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Dividends account for about 40% of total stock market return over time

Value of dividends

There are 2 ways to make money in the stock market: capital appreciation and dividends.

Capital appreciation—an increase in a stock’s price—gets most of the attention, but dividends can be surprisingly powerful.

Fidelity Investments’ research finds that dividend payments have accounted for approximately 40% of the overall stock market’s return since 1930.

What’s more, dividends can help prop up returns when stock prices struggle. For example, stock prices in the S&P 500 fell during the 1930s and 2000s, but dividends almost completely offset the decline. In the 1940s and 1970s, when inflation surged, dividends accounted for 65% and 71% of the S&P 500’s return, respectively.

“From a multi-asset income perspective, I am always seeking investments that pay a high enough level of current income to help cushion the blow during down markets. Conversely, in rising markets, this income component contributes to the overall total return of the investment. In this regard, companies that pay a sustainable and growing dividend have the potential to grow their income to keep up with inflation,” says Adam Kramer, portfolio manager for the Fidelity Multi-Asset Income Fund

References:

  1. https://www.fidelity.com/learning-center/trading-investing/inflation-and-dividend-stocks

Blackstone Group

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The Principles that Matter Most to Blackstone Group

Accountability • Excellence • Integrity • Teamwork • Entrepreneurship

Blackstone Group is the world’s leading alternative asset manager. Alternative asset investments refer to financial assets that don’t fall under the conventional categories like stocks, bonds, and cash. An alternative asset manager invests in things that average investors typically don’t have access to, according to Entrepreneur magazine.

Blackstone contends that everything they do is guided by these principles, which define their character and culture . These enduring qualities are the shared convictions that they bring to their professional and personal conduct. They are a fundamental strength of their business.

Some examples of alternative assets include private equity or venture capital, hedge funds, distressed debt, commodities, and real estate. Since they are complex investments that are not regulated by the SEC and can be illiquid, alternative investments are usually held by institutional investors or high-net-worth individuals.

Blackstone operates in four different segments:

  1. Private equity,
  2. Real estate,
  3. Hedge fund solutions, and
  4. Credit & insurance.

Many investors and institutions are looking to take advantage of alternative investments in the current low-interest-rate economic environment. With Blackstone, you have a team of financial asset management experts hunting down undervalued assets and making deals to generate returns for your portfolio. The company is known for delivering excess returns.

“Blackstone reported the best results in our 36-year history”, Blackstone CEO Stephen Schwarzman stated. “Earnings increased dramatically, and all of our key financial and capital metrics reached record or near-record levels.”

They can include private equity, hedge funds, venture capital, real estate, and derivatives contracts, which are investments that are typically intended for institutional or accredited investor. It’s an area of financial services that can be incredibly lucrative for investors.

References:

  1. https://www.entrepreneur.com/article/392789
  2. https://www.marketbeat.com/originals/blackstone-group-nyse-bx-stock-a-buy-after-posting-record-profits/

Power of Dividends

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A dividend is a share of profits and retained earnings that a company pays out to its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend.

Dividends can create a rising source of income for a lifetime. They have proven to grow at twice the rate of inflation over the better part of stock market history.

Dividends are one of three ways for a company to return value of their profits and a portion of its free cash flow to shareholders. The other two ways are for a company to buy back its shares and to re-invest in the company.

  • A share buyback is when a company uses cash on the balance sheet to repurchase shares in the open market. This has two effects.
      • It returns cash to shareholders
      It reduces the number of shares outstanding.

    As a company increase the dividend on a annual basis, the amount may be small, but over time, it can become significant.

    For example, if you own stock in a company that pays a dividend of 57 cents per share, they may announce a dividend increase of 4 cents to 61 cents. That means you get and extra 4 cents for each share you own.

    Although, it’s only 4 cents, but 4 cents on 57 cents is am7% dividend increase on each share you own. If the dividend increased by this amount, 4 cents, every year, the dividend would double in about 10 years. Thus, over time, if you stick with dividends, the money will begin to grow.

    In S&P 500 Index companies alone paid out $485 billion in dividends to shareholders.

    Dividends outpace inflation

    Back in 1980, a $10,000 investment in the S&P 500 Index paid a dividend of about $421, or 4.21%, on the initial investment. Forty years later, the dividend income had climbed to $5,724, a 57% annual yield on the original investment. And, the original $10K investment grew as well. The original $10K invested in the S&P 500 Index in 1980 would have grown into more than $287K as the stock price increased. That’s not counting the dividends paid.

    The price-only-return (which excludes dividends income) is 8.75% per year. If you add in another 3% for the dividends you receive each year, you get a total average return of about 11.75% per year.

    Dividends have proven to be a more consistent source of growing income that has outpaced inflation.

    Dividends and Total Return over that 40 year period,

    Total return is one of the most important concepts in finance, and it involves more than just the dividends a company pays out.

    The total return of a stock is the total amount your investment changes in value, calculated by adding the amount of dividend or interest income received to the investment’s capital return (i.e. change in the investment’s price).

    Total return is driven by three components: earnings growth (which fuels capital gains and the underlying intrinsic value of a stock), dividends, and changes in valuation multiples.

    Dividends have been a major component of the stock market’s overall total returns throughout history and have contributed anywhere from 25% to 75% of the market’s overall total return over the past seven decades (the remaining portion of total return is accounted for by capital gains, or the market’s change in price).

    Takeaway, dividends are a powerful wealth building tool. If you invest in perennial dividend payers and consistent dividend grower companies, and then be patient, the dividends will add up significantly over decades.

    References:

    1. https://corporatefinanceinstitute.com/resources/knowledge/finance/dividend/
    2. https://www.wesmoss.com/news/the-power-of-investing-in-dividends-generating-income-from-stock-dividends-vs-bond-interest/
    3. https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/paying-back-your-shareholders
    4. https://1.simplysafedividends.com/dividends-vs-total-returns/

    Inflation…the Enemy of Savers

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    Inflation is the enemy of those who save.

    For most of the 21st century, savers and investors have experienced a favorable period of relative low inflation stock market growth. In fact, the average annual inflation rate from 2000 through 2021 was 2.31%. Even with that “low” inflation rate, the proverbial uninvested dollar hidden under one’s mattress in the year 2000 would be worth a mere $0.62 today.

    With inflation approaching 7% in late 2021, we’re on the precipice of witnessing the rapid erosion in the value of the dollar which will create substantial risk for ordinary savers and ultra conservative investors. Keeping your money in a savings account, money market or CDs is failing to protect it from inflation.

    Instead, the best place to invest is in the economy. While large sums of money are generally required to purchase real estate or a small business, the stock market allows those with limited capital a means to invest regularly in a wide variety of businesses and benefit from the strength of the economy.

    The equity markets have a history of robust returns over the long run. Over the last one hundred years, the average annual stock market return is 10%. That means investors who stay invested are nearly doubling their investments every seven years.

    Some individuals view the stock market as too risky and they literally view investing in the market as “gambling”. But, when you choose to use less “risky” investments like bonds rather than investing in stocks, the results vary great.

    A study by NYU’s Stern School of Business gives insights into historical returns provided by an investment in U.S. Treasury bonds as opposed to corporate bonds and the S&P 500.

    Assume an investor received a $300 inheritance on the day he was born. On that date, his parents invested $100 (the inflation-adjusted equivalent of $1,630 today) in several asset classes in 1928.

    As of September of 2021, the above investor would have $8,920.90 in U.S. Treasury bonds, $53,736.50 from corporate bonds, and $592,868 in returns from an index fund that tracked the S&P 500.

    Obviously, the stock market beats “safe” investments. While bonds might play an important role in a balanced portfolio, a 100% bond portfolio will fail to achieve the investment goals for most.

    Investing a little now is better than a lot later

    “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein

    A strong argument can be made that the amount of time one is in the market is of more importance than the sum invested in stocks.

    Consistently timing the market is impossible. There literally is no human being who can claim that he or she has been successful at that task with any degree of honesty. However, timing the market is not only unachievable, attempting to time the market can lead to poor investment returns.

    Over time, this would result in an ever-falling income stream. You spent your life buying stocks because they are a great source of return, that doesn’t stop just because you retire! The market is still the best source of future returns, you should be continuing to buy more, not sell!

    If one largely invests in stocks with yields of 5% or more, you can receive a substantial annual income without cannibalizing your portfolio. Furthermore, if the average annual market return is 10%, a stock that yields in the high single digits does not need to appreciate markedly to provide market-beating returns.

    Higher yield stocks outperform more often. They distribute cash on a recurring basis, whether share prices are up or down. Prices are volatile, and at the whims of emotional investors, dividends are the profit generated by the business and distributed to shareholders.

    Any investor with an employer with matching contributions should take full advantage of that opportunity. Any investor with an employer with matching contributions should take full advantage of that opportunity.

    By investing in dividend-bearing stocks and resisting the temptation to time the markets, you can be well on your way to building wealth and achieving financial freedom.

    References:

    1. https://seekingalpha.com/article/4484316-retirement-what-novice-investors-must-know

    Wealth Building and Dividends

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    “Systems are the vehicles that are going to take you to your goals—your goals are simply the destination.” James Clear

    “We don’t rise to the level of our goals; we fall to the level of our systems.  Don’t share with me your goals; share with me your systems.” James Clear

    Are you prepared for your financial future and to build wealth? There are many benefits of investing for the long term and to building wealth. Here is a simple and straightforward checklist to get started:.

    • Start early!
    • Investing starts with a plan
    • Investment plan starts with defining and identifying your financial goals.
    • Create a savings and investment plan based on your goals.
    • Two primary goals must be creating an emergency fund and building wealth for retirement
    • Develop good financial habits
    • Pay off high-interest debt first.
    • Participate in your company’s 401(k) plan and max out any employer match.
    • Understand your risk tolerance.
    • Understand investment fees and their impact on returns.
    • Research all investments thoroughly.
    • Check your investments regularly and maintain a diversified portfolio.
    • Avoid investment opportunities that sound too good to be true.

    40% of stock market returns come from dividends

    It’s interesting that most investors don’t know how powerful stocks that pay dividends are. Dividend stocks are stocks of companies which pay out a portion of their earnings to the shareholder in the form of dividends. Between January 1926 and December 2004, 41% of the S&P 500’s total return owed not to the price appreciation of the stocks in the index, but to the dividends its companies paid out.

    An additional benefit is that, under the current tax laws, qualified dividends are taxed at lower rate instead of your standard income bracket rate which translates into more money in your pocket.

    Investors know that the best dividend stocks aren’t those with a high yield, but rather are quality businesses that can grow over time and pass along profits to shareholders through the dividend, by repurchasing shares and reinvesting in the business.

    Bottomline is that dividend-paying stocks have outperformed in the past and that they have a good chance of doing so in the future. The secret is to reinvest those dividends, and put the power of compounding to work in your portfolio.

    To build wealth, investors need to account for a range of significant, real-world challenges, including:

    • Longevity
    • Inflation and rising costs
    • Fixed income vs. equity valuations
    • Low yields

    With tens of billions of dollars trading hands every day on the New York Stock Exchange alone, it’s easy to lose sight that when purchasing a stock investors are effectively purchasing ownership interest in a business. Assume for a moment that you don’t get a quote every day for your shares in that business and that you can’t sell your ownership interest for several decades. Your focus would likely shift from price to value.

    And the value of that business, whether publicly traded or privately held, is the present value of all future cash flows. After all, what is the point in owning a business – or any investment – if you’re never going to receive any cash from it? When a company generates positive free cash flow, it has several options; the company can hold cash in reserve, fund organic growth, make acquisitions, pay down debt, or return it to shareholders through dividends or stock buybacks.

    Using dividends to pay your expenses and allow you to reinvest to get more income. You can achieve this by investing in excellent dividend-paying securities now and letting those dividends reinvest as you work towards your retirement.

    References:

    1. https://www.investor.gov/sites/investorgov/files/2019-03/OIEA_Financial_Capability%20Checklist.pdf
    2. https://www.fool.com/investing/dividends-income/2006/09/19/the-secret-of-dividends.aspx
    3. https://advisor.morganstanley.com/christopher.f.poch/documents/field/p/po/poch-christopher-francis/WhyDividendsMatter.pdf

    Beat Inflation with Dividend Stocks | Fidelity Viewpoints

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    “Stocks that can boost dividends during periods of high inflation may outperform.” Fidelity Viewpoints

    Key takeaways according to Fidelity Viewpoints

    • Dividends aren’t just nice to have, they’re essential to the stock market’s return—accounting for approximately 40% of overall stock market returns since 1930.
    • During periods of high inflation, stocks that increased their dividends the most considerably outperformed the broad market, on average, according to Fidelity’s sector strategist, Denise Chisholm.
    • Dividend-paying stocks’ regular, scheduled payments also may help to reduce the volatility of a stock’s total return.

    The economy is gradually recovering from its pandemic-related slowdown and shutdowns, and inflation has hit its highest rate in 39 years. People are emerging from the pandemic and are spending money they saved or money they’re getting from the government. Thus, a combination of soaring pent-up consumer demand and persistent supply chain disruptions has tarnished an otherwise robust economic recovery.

    The Bureau of Labor Statistics said the Consumer Price Index of food, energy, goods and services rose by 0.8 percent in November, pushing annual inflation above 6.8 percent. The level is the highest since 1982 and it also marked the sixth consecutive month in which annual inflation rates have exceeded 5 percent.

    Currently, approximately 70 percent of Americans rate the economy negatively, with nearly half of Americans blaming Biden for inflation, according to a recent Washington Post-ABC poll.

    This combination of economic challenges and consumer worries may make this an especially good time to consider investing in stocks that pay consistent dividends.

    A few important things for investors to know about dividend stocks:

    • Dividend payouts typically happen quarterly, although there are a few companies that payout monthly.
    • Many high-quality companies routinely raise their dividend payouts, helping hedge against inflation.
    • A stock’s dividend yield moves in the opposite direction of its stock price, all else being equal, so a high yielding stock may be reason for caution.

    Fidelity research finds that dividend payments have accounted for approximately 40% of the overall stock market’s return since 1930. What’s more, dividends have propped up returns when stock prices struggle.

    Dividends account for about 40% of total stock market return over time

    US stock returns by decade (1930–2020). Over various decades, dividends have remained a fairly steady component of stocks’ total returns amid more highly volatile stock prices. Past performance is no guarantee of future results. Source: Fidelity Investments and Morningstar, as of 12/31/2020.

    To invest successfully in dividend stocks, one of the keys is finding companies with strong balance sheets and with secure payouts that can grow consistently over the long haul. Moreover, it’s important to understand the concept of dividend yield, which investors use to gauge how much dividend income their investment will produce.

    Investing in dividend stocks

    When selecting dividend stocks, it’s important to keep dividend quality in mind. A quality dividend payout can grow over time and potentially be sustained during economic downturns. It’s the primary reason investors must not focus solely on yield.

    Steve Goddard, founder and chief investment officer of Barclay, prefers companies with high returns on capital and strong balance sheets. “High return-on-capital companies usually by definition will generate a lot more free cash flow than the average company would,” he says. And cash flow is what pays the dividend.

    Although overall dividend health has improved markedly since 2020 and looks good heading into 2022, it’s equally important to check a company’s dividend policy statement so you know how much to expect in payment and when to expect it. Dividend yield is a stock’s annual dividend expressed as a percentage of its price.

    It’s crucial to recognize that a stock’s price and its dividend yield move in opposite directions, as long as the dollar amount of the dividend doesn’t change. Investing in the highest-yielding shares can lead to trouble, notably dividend cuts or suspensions and big capital losses

    This means a high dividend yield may be a red flag of a problem with the underlying company. For example, a stock’s yield may be high because business problems are weighing down the company’s share price. In that case, the company’s challenges may even cause it to stop or reduce its dividend payments. And before that happens, investors are likely to sell off the stock.

    Fidelity Investments’ research has found that stocks that reduce or eliminate their dividends historically have underperformed the market by 20% to 25% during the year leading up to the cut.

    Also consider the company’s payout ratio—the percent of its net income or free cash flow it pays in dividends. Low is usually good: A low ratio suggests the company may be able to sustain and possibly boost its payments in the future.

    “As a rule of thumb, no matter what the payout ratio is, it is always important to stress test a company’s payout ratio at all points in the business cycle in order to carefully judge whether it will be able to maintain or increase its dividend,” says Adam Kramer, portfolio manager for the Fidelity Multi-Asset Income Fund.

    “It all depends on the stability of the cash flows of a company, so it’s more about that than the level of payout. You want to test the company’s ability to pay and increase the dividend under different scenarios. In general, when the payout ratio is more than 50%, it’s a good reminder to always stress test that ratio,” Kramer explains.

    Be sure to diversify as you build a portfolio of dividend-paying stocks. To help manage risk, invest across sectors rather than concentrating on those with relatively high dividends, such as consumer staples and energy.

    References:

    1. https://www.fidelity.com/learning-center/trading-investing/inflation-and-dividend-stocks
    2. https://www.barrons.com/articles/quality-dividend-stocks-51639134001
    3. https://news.yahoo.com/inflation-pinch-challenges-biden-agenda-200620196.html

    Past performance and dividend rates are historical and do not guarantee future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. Investing in stock involves risks, including the loss of principal.