Miguel Cabrera was one of the top baseball players for more than 10 years. He was reliable to play just about every day and produced a strong batting average. He even had a great year, great enough to win MVP awards with the Detroit Tigers. Sure, he had his slumps and tough times like any other player, but his solid fundamentals made him a key player through the years.
What does Cabrera and the Tigers have to do with dividend investing? Well, there are parallels. Sometimes dividend investing goes through a tough stretch, but over time it has shown to work well, produce strong cash flow, and is less susceptible to booms & busts like other riskier strategies.
Flipping on the TV each day and seeing the same few stocks lead the market higher can get worrying for a diversified investor. In fact, today more than 20% of the S&P 500 is weighted in just 5 companies – all generally in the large-cap growth consumer technology arena. Growth-oriented technology companies usually don’t pay big dividends, but they have produced some of the best returns for investors – recently.
What is a dividend investor left to do? Know that the market ebbs and flows. But, we all know this, right? What makes things hard is when a strategy we are invested in seems to stop working. Dividend investing is among those strategies. While large-cap growth & technology stocks have performed well in the last few years, high dividend areas like value and some foreign stocks have seen less glamourous returns.
At the sector and industry level, higher-yield energy stocks & financials have performed poorly. The underperformance among high dividend-paying stocks has come just since the start of 2017. While large-cap growth equities have returned about 65% in the last 3+ years, dividend stocks are up only about 10%.
This is a common theme in the stock market today – the gains are focused among a handful of giant companies. This tends to eventually reverse itself with the best stocks recently giving way to the undervalued groups today. As J.P. Morgan once said, “the market fluctuates.”
Interestingly enough, not long ago, headlines like the below were all the rage. Dividend stocks were the darlings of investors as recently as 4 years ago.
Wall Street Journal: February 2016
Dividend strategies can be criticized for being off-base. That, if a stockholder wanted income from a portfolio, he or she could simply sell the principal periodically. The problem with that is we are human beings.
Behaviorally, we don’t like to touch principal – think of a retiree who lives off the 4% yield of a balanced stock/bond asset mix. The last thing he or she wants to do is hit the ‘sell’ button. But the retiree will gladly accept the dividend check that arrives regularly in the mail (or to their online account).
Using the dividend payments as cash flow for living expenses is easier, both functionally and behaviorally.
While companies can cut their dividend at any time for any reason, they are often reluctant to do so as it signals to the marketplace that they may be in financial peril. A stock buyback program is much more likely to be slashed when things get tough.
A strong high-dividend policy also makes the execs at the firm very careful about taking on risky projects since they want to do what they can to ensure they keep paying out that high-income stream to shareholders
Another point about stock buybacks – I expect buybacks to be less popular in the coming years as this most recent bear market was exacerbated by companies who abandoned the safety of cash for aggressive stock buyback programs to boost their earnings per share. Even President Trump has spoken harsh words about buybacks as it relates to making the economic downtown worse.
Those companies, like the airlines and some energy firms, used cash flow during the good times to buy back shares of their company, leaving no rainy-day fund. Much like some banks did just before the 2008 Great Financial Crisis.
Certainly, dividends are not guaranteed to investors. Companies can do whatever they wish with their cash flow, but companies with a solid track record of distributing cash to shareholders want to keep that policy, often decades in the making, going.
What’s more, a temporary dividend cut, like many companies may consider this quarter, will likely be seen as a one-off event to maintain operations.
Banks are in solid shape, many industries that are currently being hit hard are receiving support from various stimulus programs, the federal government is providing unprecedented resources, and states are slowly reopening. Cash flow will slowly transition away from coming from the government and revert to coming from consumers going out and enjoying life.
Here the point – sticking with a strategy & discipline is the name of the game in investing. Tried & true methods like dividend investing still make sense, maybe more than ever since dividend stocks are now a better value than the high-flying handful of tech stocks that have led the market.
Featured Image: Photo by Gary Shear on Unsplash