The search for yield has been an important topic over the last cycle with bond yields trending down since the Global Financial Crisis in 2008. In the last few years, we saw the low point in yields with over a quarter of global debt having negative yield and the U.S. Ten Year Treasury yielding 0.50%, and -0.80% in Germany. In general, the search for yield has not led to the outperformance of dividend yielding stocks, especially over the past two years, as low rates made longer duration/growth stocks more valuable.
Recently, the tide seems to be turning in favor of dividend stocks in this hiking cycle, however, that observation is fraught with macroeconomic uncertainty. Here are some reasons why dividends have come back in vogue.
- Higher inflation has changed investors’ preference for real cash flows compared to uncertain capital gains.
- Dividend payers tend to be larger and more stable, and in this uncertain macro environment, the focus has shifted to steady income flows as they will likely be a key driver of returns rather than an expansion in the price-to-earnings multiple.
- The demand for income remains strong considering an aging population and uncertainty around capital gains taxes.
Two Major Ways of Investing in Dividend Strategies
Dividend investing usually takes one of two forms. The first, investing in high yielding companies and the second in dividend growth companies. The allure for high yielding equity strategies is their income potential, but that typically comes with greater risk and lower quality. High yielding companies screen well on valuation metrics, but they can turn out to be value traps, and the higher yield is usually due to a significant reduction in price, likely because of a company’s bleak future prospects.
The other way to access dividends is to invest in companies that have a history of growing their dividends that may or may not have high yields. A popular subset of dividend growing companies is called Dividend Aristocrats. Dividend Aristocrats are companies that are part of S&P 500, must be worth at least $3 billion at the time of each quarterly S&P 500 rebalancing, have average daily trading volume of at least $5 million for the trailing three-month period before each quarterly rebalancing date and most importantly have a record of increasing their dividends for the last 25 years. Higher dividend yields don’t mean much if they aren’t sustainable and that is why being part of dividend aristocrats is a distinction as it indicates a higher earnings quality.
The Lido Way
At Lido Advisors, we understand the value of dividends, earnings quality and avoiding value traps. Our Multi Factor Equity Income strategy, in addition to common factors such as value, and earnings quality also adds momentum to the mix to potentially avoid value traps with the idea to minimize the importance of yield that is due to a significant price reduction. The strategy picks between 50-55 securities from the S&P High Yield Dividend Aristocrats Index with the goal of having a similar yield and higher exposure to quality and momentum factors than the index. For more information on the strategy and how it might fit in a financial plan, please consult with your advisor.
