Dividend Paying Stocks: One Size Does Not Fit All
2017 has been a rewarding year for equity investors. Global equities, as measured by the MSCI World Index, returned just over 20% through the end of November. Although rapid growth companies were among the strongest year-to-date performers, equity income remains an important objective for many investors. As we navigate a rising rate environment, it is important to remind ourselves that not all dividend paying stocks are created equal.
For further insight, we spoke with the Shareholder Yield Team at Epoch Investment Partners (“Epoch”). Epoch manages over $48 billion in equities and serves as a subadvisor for multiple mutual funds available through New York Life/MainStay Investments.
Opening the Door to Income in the New Market Cycle
While a rising rate scenario has important implications for income investors, at present levels the outlook for equity income remains relatively attractive. As of 9/30/17, the combined dividend and share buyback yields of companies within the S&P 500 Index were almost 200 basis points (bps) above the yield of 10-year U.S. Treasury notes. Considering that central banks of developed countries are in the early stages of what could reasonably be a gradual trajectory of rate hikes, the more favorable risk/reward balance and higher income potential of dividend payers may be in favor over the next several years.
Outlook for Equity Income Stream Well Above That of U.S. Treasurys
Sources: Standard and Poor’s, Bloomberg, Epoch Investment Partners. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
Prudent dividend investing should also include an allocation to foreign stocks, as nearly 50% of the world’s market capitalization resides outside the U.S.1 Foreign companies tend to have higher dividend payout ratios than their U.S. counterparts. Why? Foreign firms tend to pay out a higher portion of earnings to investors in the form of dividends. Conversely, U.S. companies often prefer to retain excess earnings for future growth and are more actively engaged in share buyback activity.
So, what is the right balance between U.S. and foreign equities? And, what countries and industries offer the best risk/reward potential? Epoch approaches this by analyzing the individual stocks within those countries, focusing on each company’s “shareholder yield” potential (dividends, share buybacks, and debt reduction).
Think Dividends – Think Globally (Dividend Yields (%) of Broad Equity Indices)
Source: FactSet, as of 9/30/2017. Dividend yields (%) represented by the following indices: KOSPI Composite, S&P 500, Germany DAX, MSCI Emerging Markets (EM) Index, Canada S&P/TSX Composite, France CAC 40, and FTSE 100. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
A Favorable Backdrop for Stock Pickers
Unprecedented action by the world’s central banks (known as quantitative easing) in response to the Global Financial Crisis pushed yields lower, fueling demand for yield across asset classes. It also raised equity correlations, meaning stocks tended to move together as a group. However, over the past two years, we have reached an inflection point marked by a meaningful reduction in equity correlations, with stock prices moving more independently from one another. Under this new market cycle, Epoch believes the transition toward quantitative tightening will continue to suppress equity correlations at more modest levels, coupled with bouts of volatility.
This is a favorable environment for fundamental stock picking, especially for seasoned risk-sensitive practitioners that focus on the key drivers of shareholder return, with an emphasis on the dividend component of those returns.
U.S. Equity Correlations at 10-Year Lows
Source: Epoch Investment Partners. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
The Quest for Yield – Looking Beyond Dividends
Dividend investing is not a one-size-fits-all solution, particularly in a rising rate environment. So called “bond proxies”, or higher-yielding stocks with little to no growth potential, often prove more interest rate sensitive relative to quality companies with strong capital allocation policies and a history of free cash flow and dividend growth. Moreover, internally funded dividends through organic growth and free cash flow generation are generally perceived as higher quality, relative to firms that borrow in the capital markets.
While dividend growth and the source of financing are important considerations, this singular view does not capture the full yield potential of a stock. Investors need to look beyond dividends and evaluate a company’s capital allocation policies that contribute to total return potential. This is captured best through a shareholder yield or “dividend plus” approach. This investment style places equal emphasis on a company’s commitment to increasing shareholder value through cash dividends, share buybacks, and debt reduction.
Empirical research shows that stocks with the highest shareholder yield have historically outperformed the highest dividend yielders within the S&P 500 Index.2 As seen in the figure below, recent trends since the end of the Global Financial Crisis reveal a steady increase in both share buyback and dividend payment activity. In a tepid growth environment with large corporate cash balances, we expect investors to benefit from this continued trend.
Share Buybacks and Dividend Payments Have Accelerated
Source: FactSet, as of 12/11/17. Underlying data based on companies within the S&P 500 Index. Data points are in USD ($). Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.
1. Source: MSCI All Country World Index (proxy for global developed and emerging markets equity), as of 9/30/2017.
2. Ned Davis Research, time period 1/1/04 – 12/31/16.
Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.
This material is provided for educational purposes only and should not be construed as investment advice or an offer to sell or the solicitation of offers to buy any security. Opinions expressed herein are current opinions as of the date appearing in this material only.
All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.
Dividends fluctuate and are subject to change. There is no guarantee they will continue to be paid. While dividends may cushion returns in down markets, investments are still subject to loss of principal amount invested.
Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.
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The 10-year Treasury note is a loan you make to the U.S. government. It is one of the U.S. Treasury bills, notes, and bonds, and it’s the only one that matures in a decade. The 10-year Treasury note rate is the yield or rate of return, you get for investing in this note.
Basis points (bps) refer to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument.
Free cash flow is the amount of cash a company is able to generate after making required investments in the existing business, such as for new machinery and to pay for supplies.
MSCI World Index is a free float‐adjusted market capitalization weighted index that is designed to measure the equity performance of 24 developed markets.
S&P 500 Index is widely regarded as the standard for measuring large-cap U.S. stock-market performance.
The KOSPI Index is a capitalization-weighted index of all common shares on the Korean Stock Exchanges. The Index was developed with a base value of 100 as of January 4, 1980.
The German Stock Index is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. The equities use free float shares in the index calculation. The DAX has a base value of 1,000 as of December 31, 1987. As of June 18, 1999 only XETRA equity prices are used to calculate all DAX indices.
The MSCI Emerging Markets Index captures large and mid cap representation across 24 Emerging Markets (EM) countries*. With 837 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
The S&P/TSX Composite Index is the Canadian equivalent to the S&P 500 market index in the United States. The S&P/TSX Composite Index contains stocks of the largest companies on the Toronto Stock Exchange (TSX). The index is calculated by Standard and Poor’s, and contains both common stock and income trust units.
The CAC 40 is a benchmark French stock market index. The index represents a capitalization-weighted measure of the 40 most significant values among the 100 highest market caps on the Euronext Paris (formerly the Paris Bourse).
The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index, FTSE 100, FTSE, or, informally, the “Footsie”, is a share index of the 100 companies listed on the London Stock Exchange with the highest market capitalisation.
A “bond proxy” is shorthand to describe equities such as consumer staples and utilities with safe, predictable returns, but have higher yields than much of the bond market (and, crucially, yields which can grow over time).
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New York Life Investment Management LLC engages the services of Epoch Investment Partners, Inc., an unaffiliated, federally registered investment advisor. MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.