Markets
The Power of Dividend Investing
The Power of Dividend Investing
If you start talking about dividend investing at your next cocktail event, it’s possible that other patrons may not see you as the life of the party.
But that’s okay – because while dividends are not necessarily sexy, they are a foolproof way to reel in consistent, predictable returns in the market. And for decades, seasoned investors have leaned on dividends to help power their portfolios through both good and bad times in the market.
What is a Dividend?
When a company earns a profit, it essentially has two options.
1. Re-invest in the business
This is the option chosen by many high-growth companies. They pay down debt, or expand their operations to make more profit in the future.
2. Issue a dividend to shareholders
A dividend is a share of after-tax profit of a company, distributed to its shareholders according to the number and class of shares held by them.
How and when is a dividend issued?
- Both the amount and timing of dividends is determined by the Board of Directors
- Usually for public companies, dividends happen on a quarterly or annual basis
- Most dividends are declared by large and established “blue chip” companies (i.e. P&G, McDonald’s)
- Dividends are often paid if a company is unable to reinvest its cash at a higher rate than shareholders
Most importantly for investors, dividends from good companies should be predictable and sustainable. Some companies like Coca-Cola have been paying out uninterrupted dividends on common stock for over a century.
The History of Dividends
1250
The first company to ever pay a dividend was likely a French bank called Société des Moulins du Bazacle, which was formed in 1250.
1602
The Dutch East India Company was the first company to offer shares of stock. It famously paid a dividend that averaged around 18% of capital over the course of the company’s 200-year existence.
1684
The Hudson Bay Company was likely the first North American company to have paid a dividend. The first dividend went to shareholders 14 years after the company’s formation in 1670, and was worth 50% of the par value of the stock.
1910
In the early 20th century, most investors only cared about dividends. At the time, stocks were expected to have a higher dividend yield than bonds to compensate investors for the extra risk carried by equities.
2003
Microsoft declares its first dividend after 28 years of rapid growth.
Today, roughly 422 of the 500 stocks on the S&P 500 pay a dividend, including companies like 3M, Chevron, Walmart, and McDonald’s.
Why is Dividend Investing Powerful?
Most investors are aware of the power of compound interest – and dividends work in a similar way, especially when dividends get reinvested back into the company.
That’s why investing $10,000 in Coca-Cola in 1962 would have yielded more than $2 million by 2012, which is 50 years later. Dividends get reinvested to buy more stock, which produces more dividends, and so on.
The advantages of dividend investing are as follows:
- Companies can increase dividends over time. (P&G, for example, has increased their dividend every year for 60 years)
- Companies can’t fake dividends – a company either declares a dividend, or it doesn’t
- Dividends protect against inflation. (Dividends have increased 4.2% since 1912, and inflation has increased 3.3%)
- Dividends create intrinsic value, as they generate cash flow for investors
- Dividends can help combat volatility – that’s because dividend yield increases as the market price of a stock falls, making the stock more attractive
Dividends are a key way for companies to give back to shareholders, and in the right situation, dividend stocks can be a powerful component in an investor’s portfolio.
Markets
Recession Risk: Which Sectors are Least Vulnerable?
We show the sectors with the lowest exposure to recession risk—and the factors that drive their performance.
Recession Risk: Which Sectors are Least Vulnerable?
This was originally posted on Advisor Channel. Sign up to the free mailing list to get beautiful visualizations on financial markets that help advisors and their clients.
In the context of a potential recession, some sectors may be in better shape than others.
They share several fundamental qualities, including:
- Less cyclical exposure
- Lower rate sensitivity
- Higher cash levels
- Lower capital expenditures
With this in mind, the above chart looks at the sectors most resilient to recession risk and rising costs, using data from Allianz Trade.
Recession Risk, by Sector
As slower growth and rising rates put pressure on corporate margins and the cost of capital, we can see in the table below that this has impacted some sectors more than others in the last year:
| Sector | Margin (p.p. change) |
|---|---|
| 🛒 Retail | -0.3 |
| 📝 Paper | -0.8 |
| 🏡 Household Equipment | -0.9 |
| 🚜 Agrifood | -0.9 |
| ⛏️ Metals | -0.9 |
| 🚗 Automotive Manufacturers | -1.1 |
| 🏭 Machinery & Equipment | -1.1 |
| 🧪 Chemicals | -1.2 |
| 🏥 Pharmaceuticals | -1.8 |
| 🖥️ Computers & Telecom | -2.0 |
| 👷 Construction | -5.7 |
*Percentage point changes 2021- 2022.
Generally speaking, the retail sector has been shielded from recession risk and higher prices. In 2023, accelerated consumer spending and a strong labor market has supported retail sales, which have trended higher since 2021. Consumer spending makes up roughly two-thirds of the U.S. economy.
Sectors including chemicals and pharmaceuticals have traditionally been more resistant to market turbulence, but have fared worse than others more recently.
In theory, sectors including construction, metals, and automotives are often rate-sensitive and have high capital expenditures. Yet, what we have seen in the last year is that many of these sectors have been able to withstand margin pressures fairly well in spite of tightening credit conditions as seen in the table above.
What to Watch: Corporate Margins in Perspective
One salient feature of the current market environment is that corporate profit margins have approached historic highs.
As the above chart shows, after-tax profit margins for non-financial corporations hovered over 14% in 2022, the highest post-WWII. In fact, this trend has been increasing over the past two decades.
According to a recent paper, firms have used their market power to increase prices. As a result, this offset margin pressures, even as sales volume declined.
Overall, we can see that corporate profit margins are higher than pre-pandemic levels. Sectors focused on essential goods to the consumer were able to make price hikes as consumers purchased familiar brands and products.
Adding to stronger margins were demand shocks that stemmed from supply chain disruptions. The auto sector, for example, saw companies raise prices without the fear of diminishing market share. All of these factors have likely built up a buffer to help reduce future recession risk.
Sector Fundamentals Looking Ahead
How are corporate metrics looking in 2023?
In the first quarter of 2023, S&P 500 earnings fell almost 4%. It was the second consecutive quarter of declining earnings for the index. Despite slower growth, the S&P 500 is up roughly 15% from lows seen in October.
Yet according to an April survey from the Bank of America, global fund managers are overwhelmingly bearish, highlighting contradictions in the market.
For health care and utilities sectors, the vast majority of companies in the index are beating revenue estimates in 2023. Over the last 30 years, these defensive sectors have also tended to outperform other sectors during a downturn, along with consumer staples. Investors seek them out due to their strong balance sheets and profitability during market stress.
| S&P 500 Sector | Percent of Companies With Revenues Above Estimates (Q1 2023) |
|---|---|
| Health Care | 90% |
| Utilities | 88% |
| Consumer Discretionary | 81% |
| Real Estate | 81% |
| Information Technology | 78% |
| Industrials | 78% |
| Consumer Staples | 74% |
| Energy | 70% |
| Financials | 65% |
| Communication Services | 58% |
| Materials | 31% |
Source: Factset
Cyclical sectors, such as financials and industrials tend to perform worse. We can see this today with turmoil in the banking system, as bank stocks remain sensitive to interest rate hikes. Making matters worse, the spillover from rising rates may still take time to materialize.
Defensive sectors like health care, staples, and utilities could be less vulnerable to recession risk. Lower correlation to economic cycles, lower rate-sensitivity, higher cash buffers, and lower capital expenditures are all key factors that support their resilience.
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