Dividend stocks are more important than ever as central banks around the world keep interest rates low
Easy-money policies of global central banks have made dividend stocks more important than ever for investors who need income.
The U.S. Federal Reserve, European Central Bank, Swiss National Bank and other central banks around the world are in loosening mode, which is pushing down interest rates and inadvertently hurting income investors. On the other hand, U.S. stock prices are near record highs.
So a prudent strategy for dividend investors might be to scour the U.S. for underperforming shares of companies that generate enough cash to cover payouts.
Fed frenzy
Investors are convinced the Federal Open Market Committee will start a new round of interest-rate cuts as early as July 31. There has been plenty of discussion in the financial media about the Fed needing to “compete” with other central banks, whose policies have led to $13 trillion in bonds with negative yields. As absurd as that might seem, especially when developed economies aren’t in recession, this type of craven monetary policy has gone mainstream. (Here’s an IMF working paper touting the use of negative interest rates to spur economic growth during recessions.)
OK, fine. But how will that work when rates in so much of the developed world are already negative?
In his daily Out of the Box commentary, Mark Grant, B. Riley’s chief global strategist for fixed income, wrote on July 22 that the negative yields exist “for one reason only, and it is because the nations of the European Union, Switzerland and Japan have mandated that their central banks take rates to these levels so that their countries can survive.”
Grant elaborated in a later commentary: “Most nations in Europe cannot afford their budgets, or their social programs, and have lost their ability to raise taxes without having their politicians thrown into the streets, and so they manufactured money in their computer rooms and lowered the yield on their bonds, to less than zero, in many cases.”
All this, with low inflation. If you are planning to retire 10 years from now and fund a significant portion of your expenses with interest or dividend income from savings or investments, you may have to change your plans. Unless inflation quickens and forces a complete change in central banks’ policies, interest rates and dividend yields may be too low for a simple change “from growth to income” to fund your golden years.
This is why in March we listed stocks of companies with very long track records for dividend increase that had recently increased their payouts significantly.
Another piece features two money managers’ approaches to building portfolios of stocks with rising dividends.
How to get higher dividend income now
The Federal Open Market Committee’s last policy statement June 19 fed the current rate-cut frenzy. There was a clear change in the market that has helped push the S&P 500 SPX, +0.68% and Dow Jones Industrial Average DJIA, +0.65% to new highs, while prices for bonds and preferred stocks soared.
Here are large lists of dividend stocks that have the highest yields, with payouts comfortably supported by free cash flow published during the June 18-19 FOMC meeting.
A new list of potential bargains
One reason U.S. stocks have performed so well this year is that the S&P 500 Index SPX, +0.68% itself has a dividend yield of 1.95%, according to FactSet. For someone expecting a yield above 5%, that is not very impressive, but it’s infinitely higher than a negative-yielding European government bond and not far behind the yield on 10-year U.S. Treasury notes TMUBMUSD10Y, -0.17%
With the benchmark index rising 19% this year through July 19 (excluding dividends), you would be hard-pressed to find high-yield dividend stocks in the S&P 500 that have fallen this year. But it turns out there are 25 with dividend yields higher than 3% with payouts that are in most cases well-supported by free cash flow, earnings per share (for banks) or funds from operations (for real-estate investment trusts) that also haven’t cut their dividends for at least five years.
A company’s free cash flow is its remaining cash flow after planned capital expenditures. This is money that can be used to pay dividends, buy back shares, expand organically, fund acquisitions or for other corporate purposes. For the above list, free cash flow per share is for the most recent four quarters reported through July 19. If we divide free cash flow per share by the current share price, we have the free cash flow yield, which can be compared with the current dividend yield to see if there appears to be “headroom” to increase the dividend.
For the banks, free cash flow per share data isn’t available, so we used earnings per share, which for banks is generally considered to be an accurate reflection of cash flow.
For real-estate investment trusts, we used funds from operations (FFO). FFO is a non-GAAP calculation that adds depreciation and amortization back to earnings per share, while subtracting gains on the sale of real estate. In the REIT industry, FFO is generally considered to be an accurate estimate of a REIT’s dividend-paying ability.
If free cash flow yields were calculated for the two REITs on the list instead of FFO, then for Macerich MAC, +2.50% a free cash flow yield of 6.32% would mean “negative headroom” of 2.98%. By this measure, Macerich didn’t generate enough cash over the past 12 months to cover its dividend. For Simon Property Group SPG, +2.01% a free cash flow yield of 7.07% would leave “headroom” of 1.89%, showing the dividend well-covered under this calculation method.
Both REITs own shopping malls, which may explain why investors have been shying away from them, even though both have been steadily increasing their dividend payouts.
Cash flow to cover dividends is very important, especially when looking at a group of companies that may be slow growers or may even have suffered recent sales declines. This isn’t a list of growth stocks.
You can click on the tickers for more about each company, including news coverage. You should certainly do a lot more research before buying any stock. You not only need to understand what may be driving this year’s underperformance, you need to be confident in their ability to continue operating and supporting these (or higher) dividends for many years to come.
Here’s a summary of sell-side analysts’ opinions of these companies. Keep in mind that this group of analysts bases its recommendations on 12-month price targets and that a year is a short period for a serious long-term investor looking to generate dividend income.