The question is which companies can investors trust to continue paying dividends.
During the pandemic, just under 200 companies stopped paying dividends to save cash. Over the past three years, many of them have resumed dividend payments — but some haven’t, and overall dividend growth is expected to slow to 2.3% in 2023, according to Janus Henderson’s latest Global Dividend Index.
Now, even as the economy emerges from the worst of the pandemic, persistent inflation and high interest rates are putting pressure on companies’ balance sheets, which could discourage dividend payments. A handful of companies have recently announced plans to cut their dividends.
Max Wasserman, founder and senior portfolio manager at Chicago-based Miramar Capital, says several unsustainable pauses and recent dividend cuts are the result of poor capital-allocation strategies.
“What you’re seeing are companies that have inflated their payout ratios to such an extent that any disruption to their business model puts their dividends at risk,” Mr. Wasserman says. To remain on the radar of dividend ‘elite’ or mutual funds and dividend investors, and this affects their cash flow. With higher debt costs, inflation and uncertainty, they have decided to cut the dividend in response.”
Antonio DeSpirito, lead portfolio manager for the BlackRock Equity Dividend Portfolio, says the timing of a dividend cut can tell investors about a company’s underlying health. “The work we’ve done on this shows that if a business is falling out of business-cycle, it can be a red flag. It usually means that a company has a long-term secondary problem. There is little chance of the stock recovering,” he says.
seek stability
So, what should dividend investors look for in a company? Managing director and senior portfolio manager at NFJ Investment Group, Dallas-based R.K. Burns McKinney says investors should focus on a company’s dividend as well as cash flow. They say it can be tempting to look for the biggest dividend or highest dividend yield, but cash flow is a metric of stability.
“The best dividend companies are the ones that have thought it through and have a philosophy behind what they’re doing with their dividend,” he says. “It should be rooted in current cash flows and their expectations for business growth over time.”
Both Messrs McKinney and Wasserman argue that high-quality dividend payers should grow dividends meaningfully year after year, ideally keeping pace with inflation. They say capital-allocation strategies should also take into account the potential for an economic downturn or recession. For 2023, both expect high-quality dividend payers to increase payouts despite pressure on corporate balance sheets from inflation and debt costs.
“The increase may not be much,” Mr. Wasserman says. It’s on.”
Multiple strategies
For fund investors, dividend funds may offer some protection in the current market environment, says Daniel Sotiroff, a senior analyst at Morningstar Research Services, a unit of Morningstar Inc. This means that these are highly profitable companies. Investing in them can be a defensive investment in times of uncertainty,” he says. Last year, dividend funds were down an average of 6.68%, compared to a 19.4% decline in the S&P 500 index, according to Morningstar.
There are many different strategies investors can pursue with dividend funds. There are broad-based funds like the Invesco Dividend Income Fund (FSTUX), which invests in all sectors, including long-term dividend-paying companies such as Johnson & Johnson and Bank of America Corp. Its expense ratio is 0.66%.
Dividend-yield funds invest in companies that pay dividends at a higher rate than a specified benchmark index. Aniket Ullal, head of ETF data and analytics at CFRA Research, says these funds give investors the option of taking more of a sector view, as many of them invest primarily in one or two sectors.
Vanguard offers a dividend-appreciation strategy through its Vanguard Dividend Appreciation ETF (VIG). The fund tracks the S&P US Dividend Growers Index, which is comprised only of companies with a track record of increasing their dividends. The fund holds all of the stocks in the index and has an expense ratio of 0.06%.
“Each of these strategies is going to play a different role in a portfolio,” says Mr. Ullal. Decide if it’s worth it to them.”
Ms. McCann is a writer in New York. He can be reached at reports@wsj.com.