The recent slide in technology stocks has many investors taking a fresh look at their more staid dividend-paying cousins. These shares largely lagged the lofty gains of tech and social media shares during this bull market, but the tables have turned during the past month’s decline.
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The tech slide began in the same month as the dot-com bubble began bursting 14 years ago. It has allowed slower-growth, dividend paying stocks to close the performance gap slightly, as they haven’t fallen as much as their growth stock brethren.
“We see this as an opportunity…For those that still want to be in equities, (dividend stocks) are a great hedge against volatility,” asserts Adam Nugent, President of Foresight Wealth Management in Sandy, Utah.
The chart below shows the group’s relative lack of volatility during the recent selloff.
This chart is in stark contrast to the larger trend—growth has outperformed the benchmark S&P 500 relative to dividend-payers by one of the biggest relative performance spreads since the dot-com bubble burst in 2000 and 2001, according to Factset data, reminding some fund managers of the frothy Y2K era.
“It’s such a wide diversion, it reminds me of 1999,” says Steve Krawick, who helps manage $890 million as President of West Chester Capital Advisers in Johnstown, Pa. Krawick remains bullish on stocks, but has been bulking up on dividend payers in this downturn. Here’s a look at the past year, and you can see how the spread has been virtually cut in half from the early March peak as investors have taken some gains off the table.
As earnings season begins there are plenty of known headwinds for all equities: the Federal Reserve is winding down its interventionist bond-buying program and signaling rate hikes as soon as next year. Earnings growth is widely forecast to slow. And there are heightened political tensions with Russia and growing global economic concerns in China and emerging markets.
“There’s a lot of equity risk I believe, but you can’t get under the covers,” says Nugent. “Given the recent sell-off in the market, there have been some great dividend plays that are priced attractively and have great yields.”
Nugent says his firm has trimmed holdings in big winners from last year and is strategically buying dividend-paying positions. The fund manager has been putting clients into blue-chip dividend payers including GE and Wells Fargo, but also into mutual funds holding Master Limited Partnerships (MLPs) and directly into MLP names Boardwalk Pipeline Partners (BWP) and Seadrill (SDRL). MLPs generally offer hefty dividend payouts by energy-related companies but feature more complex tax implications than equities.
Yield sign for investors
Some investors have piled into higher yielding dividend stocks to generate income as a proxy for bonds, which offer historically low yields given the interest rate environment. But a number of fund managers tell FOX Business that is a bad bet.
Utilities and telecom stocks have seen volatility spike in recent interest-rate-related selloffs as these groups tumbled in tandem with treasuries. And the yield-seekers may get going if the going gets tough.
Mark McComsey, chief investment strategist at Beverly Hills Asset Management, warns this is a “hostile environment” for such strategies. “It’s a potentially crowded trade as advisers substitute dividends in place of bonds. I think investors may be discounting the risk of equities…chasing yield in the current environment is not going to end well.
“If earnings slow down and management cuts the dividend, you get a double dose of bad news. If you see the share price drop, you’re seeing investors that bought this stock for the dividend exiting at the same time (exacerbating declines).”
That was the case in 2008 and 2009 when companies, especially financial institutions, drastically cut or eliminated payouts to shore up their balance sheets amid the credit crunch and recession.
McComsey also argues that dividend stocks remain expensive and he is finding “value” in small-cap growth stocks. One name his firm recently bought is Computer Programs & Systems (CPSI).
Sharing the wealth?
At face value, it would seem to be a great time to buy dividend-paying stocks. After all, companies are paying out more cash in dividends than ever before. Howard Silverblatt, Standard & Poor’s Senior Index analyst, reports companies paid a record $312 billion last year in dividends.
And unless there’s a drastic reduction in payouts, payments in 2014 are on track to be even higher. Indeed, there has been a sharp, record rebound from 2009 levels.
Dividend Rebound Total Amount Paid 2014 est. $331 Bln 2013 $312 Bln. 2012 $285 Bln. 2011 $240 Bln. 2010 $205 Bln. 2009 $196 Bln. 2008 $248 Bln. Source: Standard & Poor’s Silverblatt also notes that 418 members of the benchmark S&P 500 paid dividends in 2013, the highest number since 1998 and a big jump from the post-dot com bear market lows in both 2001 and 2002 when just 351 companies in the venerable index paid shareholders.
Of course, Silverblatt adds that the number was a much higher, as 473 of 500 companies were regularly paying shareholders when he started at S&P during the 1970s stagflation markets, when dividends gained favor as a way to reward shareholders who saw little stock price appreciation.
But here’s the rub, the S&P analyst says: “There’s definitely room to grow payouts. Companies are only paying out 36% of what they make and they’re making more than ever.”
BofA Merrill Lynch data show that’s pretty stingy compared to the average historical payout -- 54% of profits dating all the way back to 1900.
In a recent note to clients, the firm’s analysts point out corporate America is sitting on a record high $1.4 trillion cash pile -- quite a rainy day fund, or perhaps plenty of dry powder to further boost dividends.
The strategy piece advises buying high dividend growing stocks in companies that “typically are less expensive than higher yielding stocks, with less leverage, more cash, faster earnings growth, and better global diversification.”
Some of the firm’s top S&P 500 dividend growers of the past 12 months include Helmerich & Payne, Capital One, ADT, and Starwood Hotels.
Robert Luna, chief investment officer at Surevest Wealth Management in Phoenix, favors the growing payout strategy: “We really like dividend growers here versus just high dividend payers like utilities.”
Krawick, of West Chester Capital Advisers, concurs, “The Dividend Aristocrats are a good starting point. You’re buying companies that have a history of increasing dividends over the past 25 years.”
Historically, a number of the Dividend Aristocrats have increased their dividends with spring announcements. Dividend Aristocrats Showering Shareholders April Payout Increases, Past 10 Years Chevron 7 Exxon Mobil 9 Johnson & Johnson 10 Procter & Gamble 8* (incl 2014) WW Grainger 10 Source: Standard & Poor’s
Krawick says selecting a prosperous payout pedigree is just part of the process; investors must also choose sectors and stocks wisely. He favors names such as Johnson & Johnson and Apple. And when the Fed inevitably tightens rates, he looks to history for market leadership: late cyclical stocks including dividend-paying tech, energy, materials, and industrials.
Investors may not agree on when the Fed will raise rates or when that rotation cycle will happen, but they seem to agree that the risk/reward ratio is getting higher. “Last year was better than most people expected,” says Nugent, adding, “now we are focusing on how we can protect what we made, and be more tactical. Given the environment we’re in now, dividend paying stocks as a part of the overall return are key.”