Dividend-Paying Stocks: Compelling Characteristics

Dividend-paying stocks have attracted lots of investor and advisor attention, especially when—for much of the second half of 2012 and the first quarter of 2013—fixed-income rates were at historic lows. For investors and their advisors, this situation meant that the stocks’ attractive yields were seen as the best-available income option.

Plus, dividends can cushion investors against market volatility. This was important over the past year or so, when the Dow Jones Utility Index (DJU), a rate-sensitive index, moved from 438.05 on November 15, 2012, to a peak of 537.32 on April 30, 2013.

Positive Outlook

Several factors bode well for such stocks going forward, despite the recent shift in interest-rate dynamics, experts say. First, dividend payouts have been growing and look likely to continue growing, says Mike Boyle, CFA, senior vice president of asset management with Advisors Asset Management in Lisle, Ill., who tracks roughly 40 years of dividend data.

Citing the most recent figures, Boyle reports that dividends paid in June 2013 were 23% higher than those paid in June 2012, an increase he describes as “phenomenal.”

That result isn’t a one-month aberration. When Boyle compared the most recent trailing 12-month period to the previous 12-month period, dividends paid were 17.5% higher, roughly triple the historical long-term average increase of 5.93% for comparable periods.

“Dividend growth right now is as robust as it’s ever been or at least over the 40 years that I’ve been tracking it,” he says. Fortunately, the good news doesn’t stop there.

Dividend payout ratios are hovering around 30% versus a historical value closer to 40%, Boyle notes. If companies bring payout percentages back to their average that will translate to roughly a one-third overall increase in dividends paid.

Their cash flow situations are “very, very strong,” he says. “I can find something yielding 2, 3 [or] 4% and growing that yield 10, 15 [or] 20%.” Such results can prove very attractive to many segments of investors, including retirees.

Retirement  Rush

The Baby Boomers’ impact on the demand for financial assets has been debated for years, experts say. One widespread forecast in the late 1990s was that Boomers would invest in stocks while they were working and then reallocate their portfolios to bonds at retirement to reduce volatility.

That scenario made sense for a time, recalls Josh Peters, CFA, a Chicago-based equities strategist and editor of the Morningstar “DividendInvestor” newsletter. “You had a couple of years when the market went up 25% a year like clockwork, and the idea was, you ride this wave until you retire,” he says. “Your portfolio just swells with all these capital gains, and then you sell all the stocks and you buy bonds. Back then a 10-year Treasury yielded 6 or 7%, and you could actually see how something like that could work.”

Unfortunately, investors experienced two stock market crashes, and the broad indexes haven’t even kept pace with inflation, Peters notes. Interest rates have fallen significantly, so the notion of cashing in flush stock portfolios for juicy bond yields got squashed from both ends. 

Consequently, the Boomers’ need retirement for income could spur strong demand for dividend-paying stocks in their post-retirement periods.  Unless we experience the unlikely combination of low inflation coupled with higher interest rates, Peters believes that retirees will continue to rely heavily on quality stocks to help generate the income and total returns needed to fund their retirement strategies.

“Dividend yields are going to become much more important, much more sought after, and risk tolerance is going to go down,” he explains. “People are really going to want those nice steady stable companies that spin off big dividends and keep raising them every year.”