Jun Zhu, a portfolio manager at the Leuthold Group, advised savvy investors that all dividend stocks aren’t equal.
“People probably want to look at dividend stocks in terms of where we are in the economic cycle and the interest-rate cycle,” she recently told Barron’s.
“Dividend stocks might outperform the market, [but] because of higher leverage and high payout ratios within that field, you have to be very careful,” Zhu said.
Zhu favors “higher-quality stocks with a lower risk of a dividend cut.”
Companies that do slash or suspend their dividends are often punished by the market, Barron’s explained. In 2009, for example, stocks that had dividend cuts underperformed those that didn’t by 12.4 percentage points through the first quarter of that year, according to Leuthold.
Zhu weighs the quality of top-line growth, the sustainability of earnings, balance-sheet strength, and stable stock-price performance in determining which companies classify as having quality dividends, Barron's explained.
“We see quality stocks as operationally and financially stable companies providing steady returns to long-term investors while minimizing downside risk during market downturns,” she wrote in a recent note.
Barron’s highlighted five of Leuthold’s dividend-stock picks, culled from the top 20% of a list of 1,500 publicly traded U.S. companies.
- Exxon Mobil (XOM)
- Chevron (CVX)
- Exelon (EXC)
- Prologis (PLD)
- NextEra Energy (NEE)
All five stocks sport yields of 2.4% or better, well ahead of the S&P 500’s average, and they’ve been growing their dividends.
To be sure, Zhu isn't alone in warning investors to be cautious when it comes to picking dividend stocks.
For his part, Newsmax Finance Insider Robert Ross recently warned about the dangers of blue-chip stocks' payouts.
"High dividend-paying stocks like Kraft Heinz (KHC) can often leave investors with regret. And that makes sense. Many companies must pay high dividends to compensate investors for the risk of owning the company’s stock," Ross explained.
"Some of these companies borrow money and use the debt to pay their dividend. That’s exactly what Kraft Heinz was doing. And this strategy often ends up being a disaster for investors," Ross recently wrote for Newsmax Finance.
Ross said you must look at three key things when evaluating dividends.
- The most important is the payout ratio. The payout ratio is the percentage of net income a firm pays to its shareholders as dividends.The lower the payout ratio, the safer the dividend payment.
- The second is the debt-to-equity ratio. The more debt a company has, the harder it gets to run a business. This includes—you guessed it—paying the dividend.
- The third is free cash flow. This is the amount of cash left over after a company pays its expenses. If any of these measures is flashing red, you know the dividend is in trouble.
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