Bank of America Merrill Lynch published an interesting strategy piece earlier this month that puts much of our thinking around dividend growth into charts.
We hear from clients more and more about the challenge of finding investments that balance income, income growth and protection / growth of capital. This has been further complicated by the potential for higher interest rates in the coming months and years.
When considering equities, high and often unsustainable yields can be found but are often essentially bond proxies – leaving them susceptible to capital losses, should rates rise. Our view on dividend investing remains that in order to offset a rise in rates, one needs dividend growth. We believe the way to win over the long term is to own high quality businesses at good prices that pay a fair dividend, not to own fair businesses at high prices that happen to pay high dividends.
Here are some charts from the report to think about:
- Dividend growers have actually performed positively in a rising rate environment. This contrasts to high dividend yielders which performed poorly (i.e. similarly to bonds).
- Over 60% of the companies in the S&P 500 Index pay a higher dividend yield than 5-year treasury notes. Keep in mind many of these companies are raising dividends, while the U.S. Treasury Department is far less generous.
- Even with the large number of companies paying out respectable dividends, the percentage of profits these dividends represent remains very reasonable and is actually better than historical averages.
- When comparing the “high yielders” or “bond proxies” to “high growers”, one can see dividend growers carry less debt, have lower payout ratios, are growing faster and are more geographically diversified.
- And finally, historically you would pay a premium for dividend growth. However, today you are getting it for a discount. It is clear many “high yielders” are being valued like bonds which is not where we see value.