Dividend Investing’s Not Dead

But you’ll have to act soon to lock in the highest yields in a generation.

Do you invest for dividends? If so, you might be thinking this year’s stock market has passed you by. And if you buy only ETFs, you’d be right.

Year to date, the iShares Select Dividend ETF (NYSE: DVY)—the most commonly used performance benchmark for dividend stocks—has returned less than 5 percent, including dividends. That’s about one-third the gain on the S&P 500. And it’s even further behind the Nasdaq 100, which continues to ride record investment inflows to the Big 7 Technology stocks.

Even a well-chosen portfolio of individual stocks would have had a tough time keeping up so far in 2024. The best performing dividend sector overall this year is oil and gas midstream, with the Alerian MLP Index nearly matching the S&P 500’s performance. And since mid-April, utilities and power producers have attracted investors as bets on surging electricity demand for artificial intelligence.

But only 6 of the 85 real estate investment trusts I track in my June REIT Sheet have matched or beaten the S&P 500 this year. Just 30 are in the black at all. And the S&P 500 Real Estate Sector sub-index is under water by about 4 percent. And while our Capitalist Times Income Portfolio has done well with big pharmaceutical stocks Abbvie (NYSE: ABBV) and Merck (NYSE: MRK), Pfizer (NYSE: PFE) and Johnson & Johnson (NYSE: JNJ) are underwater.

Bottom line: It’s fair to say that, with rare exceptions, dividend stocks are unloved.

Some of that unpopularity is because money market funds are yielding north of 5 percent.  Funds like Vanguard Federal Money Market (VMFXX) are basically risk-free as well. Why not capture more income and not have to worry about principal?

More ominously, the pace of dividend cuts appears to be picking up a bit. “Higher for longer” interest rates have made it simultaneously more difficult to finance growth and service existing debt. And the resulting profit squeeze has forced companies to hold in more cash—in the best cases by scaling back dividend increases, in the worst with outright cuts.

As I’ve highlighted in my Conrad’s Utility Investor advisory, the utilities sector has so far been the exception. Companies have offset increased debt interest expense with cuts elsewhere. And regulators have been supportive of investment plans, raising allowed returns on equity. Throw in tax credits for everything from nuclear power and renewable energy to carbon capture and power grid upgrades and utilities literally haven’t missed a beat.

In contrast, less than a dozen of the 85 companies I track in the REIT Sheet are still raising dividends faster than the rate of inflation. Higher borrowing costs have slowed REITs’ rate of investment to a crawl, even as higher refinancing costs take a bite out of profits.

Worse, debt-burdened tenants are having a harder time staying current on rents. And when they default, REIT landlords have no choice but to take big writedowns, as hospital facilities owner Medical Properties Trust (NYSE: MPW) did when its largest tenant Steward Health declared bankruptcy in May. Mortgage REITs and banks are also increasingly exposed to defaults, particularly if they have commercial loans.

Small wonder then that dividend stocks aren’t at the top of many investors’ buy lists this year. But they should be for two reasons:

·      A return to favor is inevitable.

When an established trend has been in place for a while, it’s all too easy to forget how fickle market fashion can be. But as recently as 2022, the Dow Jones Utility Average beat the S&P 500 by more than 20 percentage points. And for most of two decades following the Tech Wreck of 2000-02, dividend stocks generally outperformed so-called “growth” stocks.

Very likely, a return to favor requires a pivot by the Federal Reserve to lower interest rates. And this is a central bank of market watchers. So that’s unlikely to happen until inflation metrics fall further and/or the economy slides toward recession. But change will eventually come. And when it does, the current low prices and underperformance will disappear quickly.

·      Dividend yields for many best in class companies are at generation highs, even as payouts are steadily increased.

Again, if you only buy ETFs, you’re not going to benefit much if at all from this. The DVY, for example, yields barely 3 percent. And because components shift regularly and radically, actual distributions are all over the map from quarter to quarter. The June payment, for example, was -6.7 percent less than in March.

In contrast, oil and gas MLP MPLX LP (NYSE: MPLX) pays an 8 percent plus yield it actually increased by 10 percent this year. NextEra Energy’s (NYSE: NEE) current yield is roughly the same as the DVY’s. But the company raised its payout by 10 percent in March. And its affiliate NextEra Energy Partners (NYSE: NEP) pays better than 12 percent, with quarterly increases at an annualized rate of 6 percent.

These are not historically typical yields. A decade ago, for example, MPLX was typically priced to yield in the 3-4 percent range. NextEra Energy Partners yielded less than 4 percent as recently as late 2022.

There’s of course no guarantee stock prices will get back to those levels. But if they even come close, shareholders’ principal will double and better, even as dividend increases continue.

So what am I recommending now? Simply, take action by allocating some funds to dividend paying stocks you choose yourself. To get started, consider these three sectors: Electric utilities, oil and gas MLPs and residential real estate investment trusts.

All three businesses are recession resistant, demonstrated most recently during the pandemic year. And they offer low risk growth: Electric utilities and MLPs are beneficiaries of scarcity, which supports investment of leading companies. Residential REITs are benefitting from an emerging supply crunch, brought on by several years of light investment and the fact home buying is simply out of reach now for a growing number of Americans.

Most important, the best in class of each sector are paying yields as high as 10 percent, with dividends growing two to three times faster than inflation. You may never get a better chance to buy low.