almost 3 years ago • 4 mins
With many companies’ earnings now in post-pandemic recovery mode, the Finimize Community’s attention has understandably been focusing on dividends – the regular cash payouts profitable firms often make to their shareholders. So to answer your questions, I thought it’d make sense to talk through the pros and cons of two of the most popular dividend-focused investment strategies.
For many investors, dividends are hugely important: pension and insurance funds, for instance, rely on dividend income to fund their own payouts to retirees and claimants. Many retirees also rely on direct dividend income from individual investments to cover their living costs. Dividend-paying stocks’ general reliability makes them a more attractive prospect for cash-hungry investors than stocks that offer potentially greater but definitely less certain returns through “capital appreciation” (i.e. prices rising).
With that in mind, let’s look at the two main ways you can get in on dividend-focused investing: either buying super-dependable “dividend aristocrats”, or screening for attractive but overlooked payers.
Dividend aristocrats are companies that are both part of the US S&P 500 index and that have consistently increased their dividend payments for at least the last 25 years. At the last count, 65 stocks fit that bill.
👍 Pros: these companies have a long track record of increasing dividends, and are therefore likely to be a stable and reliable source of consistent dividend income.
👎 Cons: these long track records make such companies very well known to investors, so you’re unlikely to find their stocks much of a bargain.
An index of dividend aristocrat stocks has narrowly outperformed the S&P 500 (which includes these dividend payers) over the last decade, delivering 14.2% average total annual return versus 13.9% – all while showing slightly lower volatility.
This time I filtered for:
1️⃣ Dividend yield >5%: A high dividend yield (dividing next year’s projected payout by a company’s current stock price) suggests not only an attractively priced stock, but one that’s expected to generate plenty of cash.
2️⃣ Positive sales and earnings growth: A consistent track record of sales and earnings growth over the last five years bodes well for the future. That should be captured in analyst forecasts of positive earnings growth over the next five years.
3️⃣ Market capitalization >$10 billion: The metrics above are more likely to be reliable for large and stable companies than smaller and more volatile ones. Sifting out the latter helps reduce the riskiness of our screen.
4️⃣ Positive analyst recommendations: Only including stocks analysts in aggregate recommend buying acts a sense-check on investor sentiment, as well as filtering out companies with major obstacles to meeting their forecasted dividend payments.
This four-part screen threw up nine stocks from around the world which you can see (sorted by company size) in the table below. You can also check out the full screen and make any adjustments of your own here.
👍 Pros: screening companies based on desirable characteristics could help you uncover opportunities other investors are missing, potentially setting you up to profit as they catch on.
👎 Cons: the dividend stock opportunities here are riskier than the established aristocrats. These companies don’t have the same track record of increasing dividends, and are predominantly in “at-risk” industries like energy. Oil and gas companies are both heavily reliant on a post-pandemic economic recovery for their earnings to bounce back and hoping to avoid getting shafted by new environmentally minded policy initiatives.
There are two exchange-traded funds that track dividend aristocrats: the FT Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF (ticker: KNG), and the ProShares S&P 500 Dividend Aristocrats ETF (ticker: NOBL).
As for the firms thrown up by the screen, stock markets are generally good measures of value – and these shares may be cheap (and their dividend yields high) for a reason. Like other valuation metrics, a high dividend yield could indicate a too-low share price – or a too-high dividend forecast. Knowing which it’s more likely to be will require further analysis.
So rather than seeing these screened stocks as bargains, you might be better off thinking of them as investment opportunities where the balance of risk to reward appears skewed in your favor, making them worthy of further research.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.