Will High Dividend Stocks Keep Outperforming?

Source: Thinkstock

Source: Thinkstock

The stock market hasn’t had such a great year. The Dow Jones Industrial Average is down about 0.5 percent year to date while the S&P 500, which is perhaps a better barometer of the overall stock market, is up by 4.2 percent. Considering how well stocks performed last year this doesn’t seem so bad. After all, stocks should consolidate strong gains and no asset class is going to move up in a straight line. However, as an investor you should find ways to be tactical and to outperform the market, especially when it is weak.

One group of stocks that has been outperforming this year is high dividend paying stocks. These are stocks of companies that typically pay out a large portion of their profits in the form of dividends. They tend to underperform in a strong stock market, but they outperform and protect you from the downside in a weak market.

The Global X Super Dividend ETF (NYSEARCA:SDIV) illustrates this outperformance. The fund holds a collection of global dividend paying stocks yielding nearly 6 percent in the aggregate, meaning that their average dividend yield is over 3-times higher than that of the S&P 500. In addition to making monthly dividend payments, the fund is up over 8 percent this year, beating the S&P 500 by 4 percent. Since it is a global stock fund it is worth mentioning that the Super Dividend ETF is beating the performance of the global stock market — as measured by the Vanguard Total World Stock Index ETF (NYSEARCA:VT) — by 6 percent, and its dividend is more than twice as large.

Dividend paying stocks are outperforming for a couple of reasons.

First, a stable dividend is a sign that management is confident in the company’s long-term profitability. Companies, and particularly American companies, are reluctant to raise their dividends unless management is confident in the company’s ability to pay that dividend even if earnings decline. This is why so many American companies earn 2 – 4 times as much money as they pay out in dividends: they want that layer of protection in the event of a recession (note that foreign companies are more willing to pay a higher portion of their profits out in the form of dividends and they are more likely to cut their dividends should earnings decline). The fact that the companies in the Super Dividend ETF are paying such a high dividend demonstrates these managements’ confidence in their businesses. This indicates that we should be confident as well.

Second, interest rates are low, and Treasury Bond yields are falling, and this makes dividends more attractive by comparison. Now, the bad news is that the Federal Reserve is planning to stop quantitative easing in a couple of months, and this could cause interest rates to rise. If this happens then dividend stocks will be less attractive relative to bonds, and they are vulnerable to a correction. But high dividend stocks are probably less vulnerable considering that the spread between their yields and Treasury Bond yields is greater. As long as the companies in question can maintain their payouts investors should be safe.

Given these points I think high dividend paying stocks are poised to outperform. Investors have a couple of options. The first is the Super Dividend ETF, which I have already mentioned. The fund has a sister—the Global Super Dividend U. S. ETF (DIV), which focuses on U. S. companies, although the yield is lower, and I think it is at a disadvantage as the fact that it doesn’t own foreign stocks is restrictive

Investors can also go hunting for individual stocks. However this can be tricky because often times companies have high dividend yields because investors are skeptical that they can continue to pay them. So if you do buy dividend paying stocks make sure that you buy high quality companies, and make sure you understand where the money for the dividend is coming from.

Disclosure: Ben Kramer-Miller has no position in any of the securities mentioned in this article.

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