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Advisor Insights

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It still makes sense to buy dividends

Yes, companies with high yields are expensive, but advisors can still find plenty of good buys for their clients.

By: VIKRAM BARHAT

Date: October 17, 2016

Spooked by market volatility and lured by the prospect of juicy dividend payouts, investors have been shovelling money into high-dividend-paying stocks. That hunger for yield has pushed up prices of these “bond-like” equities.

But although a dividend-paying stock provides a consistent stream of income while letting investors tap into the stock market’s upside, some argue that it’s becoming increasingly difficult to find yield as valuations on dividend payers has become stretched and market volatility makes these stocks riskier.

However, it’s not time to give up on dividends, says Joanna Bewick, portfolio manager in the Global Asset Allocation (GAA) group at Fidelity Investments, who is also co-manager of the Fidelity Strategic Income Fund. She does say that valuations are high, but they’re high on any bond-proxy-like security.

“Anything that’s fixed-income-oriented has high valuations right now, from treasuries to high-dividend-yielding stocks,” says Ms. Bewick.

Instead of encouraging clients to sit on the sidelines, though, advisors can navigate this environment cautiously. “The income need is persistent, and we need to stay invested and not try to time the market,” she explains.

Think total return

Investors and their advisors, Ms. Bewick stresses, need to think about the total-return context. Total return has two components: price return and income return, and “you need to be looking for stocks that have dividend yield, but also have the opportunity for price appreciation and growth, both in terms of business and dividend,” she says.

Dividend yield is calculated by dividing annual dividend income by the current stock price. So a higher yield could well be a function of falling stock price. “And for that reason, we’re frequently not going to be looking for the highest-dividend-yielding stock,” she says, noting that “many times, dividends are high for a reason.”

Despite the current overall higher-valuation environment, Ms. Bewick continues to look for names with low price-to-earnings ratios and solid growth prospects. She also tries to mitigate volatility, but points out that investors need to know that their high-yielding stocks will see more ups and downs than bonds will.

“We’ve all seen over the past 15 years that there can be some vicious downturns in the equity market,” says Ms. Bewick. “That’s part and parcel of owing equities. So if you’re going into this space, you need to think of yourself as an investor, not a trader.”

Not just utilities anymore

Traditionally, people had utilities and telecom as go-to sectors for dividend-paying stocks, but they’re not the only game in town anymore.

“We’re looking to the technology sector, [where] many companies are now paying dividends,” says Ms. Bewick, pointing out that Apple Inc. is one reason why more tech companies are giving money back to shareholders. “Apple has made many things cool – one of them is dividends.”

The faster-growing tech sector offers a different model where it’s possible to have both price appreciation and dividend income, which “is most desirable in maximizing returns,” she says.

Some of the beaten-up sectors, like industrials and energy, are also offering value in the form of attractive price-to-earnings ratios and dividends.

“Select names in the energy sector have been through a turbulent time recently,” she says, adding that when “oil prices stabilize, some of these high-quality names will come out as winners.”

Quality counts

Pay close attention to a dividend’s quality, not just quantity, says Ms. Bewick. A good dividend is a sustainable dividend, so people should think about the stability of the dividend and the cash needs of a particular company.

One way to judge that sustainability is to look at a company’s dividend payout ratio: the dividend per share divided by earnings per share. A higher number means a company may be paying out more than it’s earning, and that it may need to cut its dividend in the future.

In terms of how high might be too high when it comes to payouts, Ms. Bewick looks to the S&P 500, which has a dividend yield of about two per cent, as a benchmark.

“Anything north of that would be in the category of the high-dividend-yielding portfolio,” she says, urging advisors, however, not to treat dividends as a bond payment.

“We also want to look for growth in these companies, because after all that’s what equities are all about,” says Ms. Bewick. “Bonds mature at par, but equities have the potential to increase in price and provide capital returns.”

And for that reason, more than the price of a stock, it matters what long-term value a company brings to the portfolio. Stay invested and give your portfolio time to work, says Ms. Bewick, even if a pullback happens.

“Over the long term, the markets go up – they always have,” she says.

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