For the past eight years, it’s been a fantastic time to buy and hold dividend paying stocks. Why? For one simple reason. They’ve been the best game in town. With interest rates so close to zero, investors have had a choice between low-yielding bonds or moderate-yielding stocks with the probability of some share price growth (as long as you don’t try to time stocks day to day).
Wall Street has paid attention too. Over the past few years, dividend payouts have soared, along with share buybacks as well. In fact, during the last two years, the total dividend and buyback payout has exceeded the total profits made by corporate America on average.
That’s why some see this golden age of dividend investing ending. Companies are taking on debt—and using it to reward shareholders rather than invest in their business and expand it further. But we’re talking about the market as a whole—some companies have done well and some haven’t. Many companies in the energy sector slashed or eliminated dividends entirely during the oil bear market of the past two years.
But, if you know where to look, there’s still plenty of opportunity to invest in quality, income-producing stocks. While the average S&P 500 stock trades at 24 times earnings, closing in on bubble territory, there are still many individual oversold opportunities.
What do I like in the dividend space? Income growth. A company that can consistently raise dividends year over year is likely to be the kind of company that has other characteristics that make it worth owning for the long haul for growth prospects as well.
What’s more, dividend growth is easy for investors to understand. It means an increasing amount of cash coming your way every year. It’s not like a company’s earnings growth or share price growth, which can fluctuate wildly. It’s a more consistent growth, provided you’re willing to buy for the long haul.
When it comes to dividend growth stocks, many investors start with the Dividend Aristocrats—stocks that have a history of increasing the income paid to shareholders every year for at least the past 25 years. And if you look at those stocks, you’ll see nothing but familiar corporate names. You’ll also see that most are still trading closely to the overall market, which makes them pricy.
My preferred investment spot right now is in what I call the “Junior Aristocrats.” These are firms that have started paying dividends, have been raising them regularly, but haven’t done so for the past 25 years.
Many of those companies are familiar names in the area of big tech. Cisco Systems (CSCO) is a perfect example. With a 3.4 percent yield as I write, shares offer about 70 percent more income per dollar than the average S&P 500 stock, which yields just around 2 percent. Even better, at 14 times earnings, Cisco trades at a discount of over 35 percent to the average S&P 500 stock.
But here’s the kicker, and where the golden age of dividend investing can go platinum: Like many tech companies, Cisco operates internationally. They keep their cash local, to avoid paying tax rates of up to 40 percent to repatriate it to the United States where they’re headquartered. Proposals to lower that tax rate, either permanently or temporarily, haven’t gotten much traction. But they might under the new presidential administration as part of a broad-based tax reform initiative.
With billions on the books overseas, Cisco and other tech giants like Microsoft (MSFT), Intel (INTC), or Apple (AAPL), have a lot of cash. It doesn’t need to be entirely reinvested in the business—but at the very least, repatriating that cash without losing so much of it in taxes would significantly reduce the incentive to take on more debt. But more likely, these junior aristocrats could simply increase the cash payouts to shareholders.
Investing for dividend growth is a simple and effective long-term strategy. While many traditional firms remain pricy, they won’t be so forever. And tech giants that have started paying dividends in recent years are the “Junior Aristocrats” likely to become future dividend giants. Even better, they’re a sign of clear value in a still-pricy market.
It’s a golden age of investing. And while it might be under pressure from rising interest rates, if you’re investing in the right space, regulatory and tax reform could lead to substantial increases in payouts over the next few years.
That said, there are a few places that look a bit more dangerous right now. I wouldn’t throw out a red flag—but at least a yellow warning one.
What don’t I like in the dividend space right now? High current payouts with low dividend growth. While I’ll make an exception for companies that are structured to pay out most of their income—like real estate investment trusts REITs or business development companies—BDCs. But even with those companies, the high level of payouts makes capital gains a much tougher proposition. If you can buy on a large enough selloff and have the stomach to sit through some big moves, you could do fine over time. But it’s a question of getting the timing right.
Don’t get me wrong, most REITs are doing well operationally, but rising interest rates are creating a whipsaw in prices among traders. A steady player like Realty Income (O), a great company to own at the right price, shouldn’t be making bigger swings than the overall market on the average day. But it’s a sign of the apprehension in the high-yield space right now. Wait for that uncertainty to become full-blown fear before you buy again.
And, in the past year since the Fed first started hiking interest rates, these high-yielders have sold off heavily but have since recovered. These sectors are also sensitive to changes in interest rates, given the high amount of debt that these companies employ to generate their returns (particularly in real estate). So, if there’s another big selloff in this space, it might create more buying opportunities. For now, that area is a hold. Focus on growth. In short, it looks like a good time to take some money off the table there and buy dividend growth names in the tech space instead.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and is managing editor of Financial Intelligence Report.
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