Slower dividend growth can be hard, particularly for fixed-income retirees.
By Jeff Brown | Contributor July 11, 2016, at 9:13 AM
Investors who favor dividend-paying stocks have been getting some bad news recently: dividend growth is slowing down. And that could force some investors to change their plans.
“If dividend growth is lower than expected, this will impact millions of retirement plans and more and more people will have to retire later than they planned,” says Doug Carey, president of WealthTrace, a financial advisor in Boulder, Colorado.
So are dividend-payers no longer appealing? No, they’re still attractive, many experts say.
“Dividend payers are a safe haven in some ways in a market that is as volatile as it is now,” says Jay Srivatsa, CEO of Future Wealth in Los Gatos, California. “It is unlikely that lower yields will be offset by higher stock prices.”
He warns that “lower returns after a massive bull market could be the new normal. Stepping back into the market and owning dividend-paying stocks is a wise step for most.”
Lower dividend growth can be particularly tough on fixed-income investors such as retirees, says Russell Robertson, owner of Alidade Wealth Partners in Atlanta.
“It is possible they could see their standard of living slip if dividend growth fails to keep up with inflation. For young and mid-life investors, we still view dividends as a great way to build a portfolio,” he says.
Dividends are a share of company earnings paid out to investors. Some non-believers say a company that increases its dividend is signaling that management can’t think of anything better to do with cash, like investing in research and development, or to build new plants.
But lots of fixed-income investors love dividends. They use the cash for living expenses or figure they can reinvest it better than the company’s executives. So the faithful like stocks with high yield, which is dividends paid over the past year divided by the stock’s current price.
Many investors go further, favoring stocks that have raised dividends consistently. In fact, Standard & Poor’s, the market-data and ratings agency, compiles a list of dividend aristocrats, which are stocks that have raised their dividends every year for at least 25 years.
During the recovery following the financial crisis, many companies raised dividends as a result of higher earnings, and to meet demand from shareholders seeking higher yields as the Federal Reserve reduced interest rates, Carey says.
These days, many companies are stingier with dividend increases, skip them altogether or, to shareholders’ horror, actually reduce them. In a Web interview on the site of Morningstar, the market-data firm, the editor of the company’s DividendInvestor newsletter, Josh Peters, says that for stocks in the Standard & Poor’s 500 index “the slowdown in dividend growth is really starting to bite.”
The S&P 500 yields about 2 percent, compared to 4 percent or more for much of the 1970s and 1980s.
The period from 2003 to 2015 was a kind of golden era for dividend growth, kicked off by Microsoft Corp.’s (ticker: MSFT) decision to pay its first dividend, Peters says, “There were some other tech companies like Intel (INTC) that had paid before, but that was the real landmark event,” he says.
He notes that 2003 was also the year tax rules were changed so that dividends received the same preferential treatment accorded long-term capital gains – a maximum 15 percent tax rate for most investors. Previously, dividends had been taxed at the higher income-tax rates.
“Most of that time, in that 12-year period, year-over-year dividend growth was in the double digits,” Peters says, adding the exception was during the financial crisis of 2008 and 2009, when dividends dropped.
But in the first quarter of 2016, year-over-year dividend growth dropped to less than 5 percent, about the long-term average, Peters says, citing figures from Standard & Poor’s. That followed slowdowns in the last half of 2015. The reason: corporate earnings are not growing, and companies are now paying out only 50 percent of their earnings as dividends, the lowest payout ratio since the early to mid-1990s, Peters says.
In addition to tighter profit margins, many firms are finding other uses for their cash, says Russell Robertson, owner of Alidade Wealth Partners in Atlanta. “Companies have been increasingly turning to share buybacks instead of dividend growth to generate shareholder value.”
Buybacks reduce the number of shares in circulation, raising earnings per share and, companies hope, pushing up the share price. Robertson is not convinced this will work as well as companies hope, and he suggests investors therefore take a dividend slowdown as a serious matter. “We do not expect lower (dividend) yields to be offset by rising stock prices, and think that investors should prepare for lower returns going forward,” he says.
James Pollard, founder of PersonalFinanceGenius.com, blames financial uncertainty for the dividend slowdown. “I believe that some companies are looking to retain their cash if and when an economic downturn happens,” he says. “It’s a smart move, but it negatively impacts income investors. Companies are just being more cautious.”
There are still some generous dividends out there, of course, but what’s a dividend aficionado to do in this situation?
Peters recommends seeking out stocks with dividend yields in the 4 to 5 percent range.
Pollard favors energy companies, which he thinks were punished too much by falling energy prices, leaving some with high yields. “I locked in some nice dividends,” he says. He also likes financial-company stocks.
Carey likes Altria Group (MO) and Exxon Mobil Corp. (XOM), yielding 3.27 percent and 3.13 percent, respectively. “They both raised their dividends during the last recession, their yields are relatively high, and they have a long history of increasing dividends.” Carey says.
“Popular alternatives to dividend stocks have been REITs, and BBB/BB corporate bonds,” Robertson says, as well as international companies, which tend to offer a higher dividend than domestic dividend payers.”
While investors are often wise to ride out a reversal, not many experts think dividend growth is likely to pick up anytime soon.
“Companies are likely to use their earnings to pay down any debt they have or will incur if [an interest rate] increase occurs,” Pollard says. “I think payout ratios will decrease over the next year or two, but it’s a necessary evil in order to sustain growth long-term.”
Source: US News & World Report
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