Capital Ideas^TM

The market pivot away from growth stocks over the past year has brought the dividend component of total stock returns back into focus.

Dividend-payers in the S&P 500 Index have outpaced the broader market by a significant margin over the past 12 months.¹ With the US Federal Reserve intent on tightening monetary policy to contain inflation, investors will likely continue to be less willing to pay up for high-multiple stocks and therefore dividends should remain a key consideration in investment decisions.

We asked two of our portfolio managers who have experience managing strategies with a focus on dividends and preservation of capital to share their thoughts. Below, Alan Berro and Will Robbins discuss how they are navigating the current investing environment for US equities and offer their medium-term outlook.

1. Looking for near-term visibility of cash flow and earnings

For now, we prefer companies where there is greater visibility on near-term cash flows and earnings, and sufficient pricing power to help blunt the impact of inflation. We see opportunities across industries within energy, industrials and health care.

So long as a company’s cash flows and earnings are visible and can easily support the dividend, we prefer to continue to hold that company. Johnson & Johnson is an example of a company that has spanned the value and growth spectrum. It has continued to deliver on its three business lines: pharmaceuticals, medical devices and consumer products. Its acquisition strategy has expanded its portfolio of innovative products, and it’s been a consistent dividend payer.

The repricing that we are seeing in many traditional areas of growth – such as software, social media, digital payments and semiconductors – could create select opportunities, though valuations and fundamentals may not be there yet. We will need to see business models adjust to the new reality of higher interest rates, scarcer availability of capital, re-adjustment of supply chains and higher labour costs.

The sustainability of the dividend matters to us. In the past decade of a growth-led market, corporate management teams juggled between share buybacks and paying a dividend as a way to allocate excess cash. Where appropriate, we are encouraging companies to maintain or grow the dividend.

Once established, managements are reluctant to cut the dividend. Therefore, we find that dividends impose a level of discipline on management teams in how they manage their capital structure. Many investors know this, but it’s worth restating that over the past century, close to 40% of equity performance has come from dividends (see chart above).

We are not dogmatic about the growth-value divide. Many well-known companies have swung between value and growth over the past two decades; Home Depot and UnitedHealth Group are two such examples. Over the years, we have invested in select companies with lower price-to-earnings multiples and held them in our dividend-oriented strategies even as valuation multiples expanded, if the combination of business fundamentals and the dividend continued to provide an attractive total return proposition.

1. As at 26 October 2022. Based on the total return of the S&P 500 Dividends Aristocrats index versus the S&P 500 Composite index. Returns in US dollars.

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.