Financial advisors concerned about the outlook for stocks given the length of the current bull market — now in its seventh year — expectations of a Federal Reserve rate hike and a slowing U.S. economy might want to consider favoring dividend-paying stocks for their clients.
In their latest note to clients this week, Goldman Sachs equity strategists wrote that dividends and buybacks will be "the sole contributor to the total return in stocks for the next 12 months" because stocks are expensive. The median stock in the S&P 500 is trading at 18.2 times earnings — the 99th percentile of historical valuation price-to-earnings ratio, creating a "limited scope for further upward expansion," according to Goldman.
There are other reasons to favor dividend-paying stocks this year:
—The yield on the S&P 500 is 1.92%, which, according to John Buckingham, chief investment officer of Al Frank Asset Management, is competitive with the 2.2% yield on the 10-year U.S. Treasury. Moreover, stocks have a much greater potential for capital appreciation than Treasuries.
— Stock dividends have been rising and could rise more this year. Buckingham says 381 companies in the S&P 500 hiked dividends in 2013 and 375 did so last year, but "payout ratios are still relatively low so corporate America continues to have the capacity to increase dividends."
Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, says companies paid out a record $93.6 billion in the first quarter, continuing a trend of rising quarterly dividends that began two years earlier and has room to grow. "Investors are getting more than they ever got before, but that doesn't mean companies are being generous," says Silverblatt. "Companies are paying out only 37%-38% of GAAP earnings to dividend holders, but historically they paid out 52%."
— Dividend-paying stocks, like many stocks, have historically performed well in past periods of rising rates, despite reports to the contrary, says Buckingham. The key for performance will be earnings. "If the stocks have higher growth rates, and can raise the dividends as interest rates rise, these stocks will be less sensitive to interest rates and likely a good place to be invested," writes Ryan Wibberley, CEO of CIC Wealth, a financial advisory firm in the Washington, D.C. metro area, in Forbes. Six months before and 12 months after, stocks overall have gained ground, notes Buckingham.
