Looking at Dividend Yield in a Different Light
Since the beginning of 2017, global equity returns have been dominated by higher growth stocks, in particular, information technology firms with little to no emphasis on cash dividends.1 Against this backdrop, high dividend paying stocks performed well on an absolute basis, but lagged the broader market.2 Despite the recent weakness, fundamentals for quality, dividend growing firms remain well intact. As we navigate a rising rate environment, it may be prudent to broaden the conventional wisdom of dividend yield.
For better perspective, we spoke with portfolio manager, Kera Van Valen, CFA, of the Shareholder Yield Team at Epoch Investment Partners (“Epoch”). Epoch manages over $46 billion in equities and serves as a subadvisor for multiple mutual funds available through New York Life Investments.
Is the Recent Weakness Overdone?
So, why have traditional dividend paying sectors underperformed their growth-oriented counterparts as of late? This is partially due to investor concerns of rising interest rates and quantitative tightening (QT). Yet, rising rates on the back of stronger economic data are generally a positive indicator for overall corporate health and equity returns. Furthermore, leading central banks, including the U.S. Federal Reserve, have repeatedly gone on record saying they expect to take a gradual and measured approach to policy normalization—one that could take several years. We believe the relative weakness of dividend-paying companies has been overdone, especially for high-quality companies committed to increasing shareholder return through broader activities, including share buybacks and debt reduction.
Traditional Dividend Paying Sectors Lagged
MSCI World Sector Performance (January 2017 – March 2018)
Source: Morningstar. Annualized returns within the MSCI World Index. Past performance is not indicative of future results. It is not possible to invest in an index.
Relative Valuations Have Improved
Although Epoch does not invest based on valuations, the price-to-earnings (P/E) multiples of traditional dividend paying sectors (consumer staples, real estate, telecommunication services, and utilities) have improved and are now at more attractive levels, compared to recent years. With that said, Epoch believes the financial metrics of free cash flow are a more reliable measure of corporate health. More precisely, the investment team views valuations within the context of free cash flow and dividend yield. At current levels, Epoch is finding more opportunities to generate a sustainable and attractive dividend yield.
MSCI World Sector Valuations
Forward Price-to-Earnings (P/E) versus Three-Year Average
Sources: Thomson Reuters Datastream, New York Life Investment Management, as of 3/31/18. Past performance is not indicative of future results. It is not possible to invest in an index.
Fundamentals Supported by Compelling Catalysts
Corporate fundamentals are currently attractive across several different metrics and may continue to accelerate on positive catalysts stemming from disruptive technologies, commonly referred to by Epoch as “Tech is the New Macro”. Technological innovation has created a capital-light world with far-reaching benefits, particularly for firms with efficient capital allocation policies. Return-on-equity (ROE) and profitability improvement have incentivized companies to redeploy cash flow to pay dividends and share buybacks, as companies need less absolute cash to reinvest for the same level of production.
The recently passed U.S. Tax Reform and Repatriation bill is also worth noting, as it enhances the potential for higher shareholder yield distributions over the next several years. By some estimates, repatriation is expected to add nearly $800 billion to corporate cash.3 The big question is: How will increasing levels of free cash flow get allocated? Company surveys suggest rising dividend payouts along with meaningful increases in share buybacks and debt reduction.
How Will Increasing Levels of Free Cash Flow Get Allocated?
Corporate Estimates on the Use of Repatriated Cash
Source: 2017 Bank of America Merrill Lynch Corporate Risk Management Survey. Companies surveyed chose all options that applied.
Greater Income Potential with Shareholder Yield
Equity-income investors place heavy emphasis on the absolute level of dividend yield, but in the process, often overlook the full income potential of a company. Shareholder yield is a more robust and holistic measure that takes into account dividends, share buybacks, and debt reduction. This powerful combination provides a unique solution for collecting income that extends beyond cash dividends. It is especially important in a rising rate environment, as stocks with high shareholder yield, in effect, help reduce equity duration (interest rate sensitivity) and have historically proven more resilient, outperforming with less risk.
Source: Epoch Investment Partners, Inc.
1. Global equity returns, as measured by the MSCI World Index. Growth and information technology stocks within the MSCI World Index.
2. High-dividend paying stocks, as measured by the MSCI World High Dividend Yield Index.
3. Source: Bloomberg, “New Grist in Tax-Cut Debate Is $800 Billion Buyback Estimate”, 3/2/18.
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.
The information contained herein is general in nature and is provided solely for educational and informational purposes. New York Life does not provide legal, accounting, or tax advice. You should obtain advice specific to your circumstances from your own legal, accounting, and tax advisors.
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.
Actively managed strategies employ portfolio managers who decide, within the constraints of a prospectus, how assets are invested. For this service, actively managed strategies typically charge higher fees than unmanaged or passively managed strategies.
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.
The MSCI World High Dividend Yield Index is based on the MSCI World Index, its parent index, and includes large and mid cap stocks across 23 Developed Markets (DM) countries*. The index is designed to reflect the performance of equities in the parent index (excluding REITs) with higher dividend income and quality characteristics than average dividend yields that are both sustainable and persistent. The index also applies quality screens and reviews 12-month past performance to omit stocks with potentially deteriorating fundamentals that could force them to cut or reduce dividends.
P/E Ratio (price‐to‐earnings) denotes the weighted average of all the P/Es of the securities in the fund’s portfolio.
P/E multiple expansion is the concept of investors willing to pay a higher multiple or higher price for a stock per unit of earnings.
Quantitative Tightening (QT) is a course of action by a central bank to tighten monetary policy.
Repatriation is the process of converting or transferring corporate money or property from a foreign country back to its home country.
For more information about MainStay Funds®, call 800-MAINSTAY (624-6782) for a prospectus or summary prospectus. Investors are asked to consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus or summary prospectus contains this and other information about the investment company. Please read the prospectus or summary prospectus carefully before investing.
New York Life Investment Management LLC engages the services of Epoch Investment Partners, Inc., an unaffiliated, federally registered investment advisor. New York Life Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. New York Life 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.