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In an environment of historically low interest rates, it is understandable that many investors have sought out equities with high dividend yields as a strategy of generating attractive total returns. Yet, in many cases, investors' emphasis on income has come at the cost of limiting their potential for capital appreciation.
The prospects for limited capital appreciation arrive from at least two different sources. The first is that investors may be overpaying for U.S. stocks with the highest dividends when compared with those with the highest rates of dividend growth. The second is that U.S. stocks with the highest dividend yields tend to be in slow-growth sectors, such as the utility or telecom sectors. Therefore, investors overly focused on high dividends may be not only overpaying for stocks, but also doing so in sectors that typically experience minimal growth.
Source: Standard & Poor's, Compustat, FactSet/First Call, and BofA Merrill Lynch U.S. Equity & U.S. Quant Strategy. Valuations are based on the median forward P/E multiples for the highest quintile of S&P 500 companies by dividend growth and dividend yield over the period 12/31/1992-12/31/2012.
So, instead of domestic equities with high dividends, investors might look to the equity of companies with a long-term track record of growing dividend payouts. This history can reflect several positive attributes about a company, including a record of strong profitability, healthy balance sheets, and commitment to shareholders. Since 1972, these aspects of "dividend growers" have, historically, contributed to higher equity returns and lower rates of equity volatility when compared with "dividend payers," according to Ned Davis Research.
Despite the positive attributes of companies with high rates of dividend growth, there could be concerns that a change in the economy could suddenly curtail further increases in dividend payouts. But the significant strengthening in corporate profits over the past several years far outpaced the continuing growth in dividend payouts. In fact, the recent dividend payout ratio is near its lowest point in 60 years.
Source: Standard & Poor's, Compustat, FactSet/First Call, and BofA Merrill Lynch U.S. Equity & U.S. Quant Strategy. The dividend payout ratio is the percentage of earnings paid to shareholders in dividends calculated by dividing dividends/share by earnings/share. Long-term average reflects the period 01/01/1900-12/31/2012. Prior to 1957, when the S&P 500 Index was incepted, the chart and the average reflects the top 500 publicly traded companies by market capitalization as defined by BofA Merrill Lynch U.S. Equity & U.S. Quant Strategy.
"So there are reasons to be optimistic about further dividend growth because low payout ratios and high cash positions on balance sheets indicate that companies should be able to grow their dividends going forward," said Steve Lipper, Lord Abbett Investment Strategist. Further dividend growth could be a reflection of established corporate stability that could continue to support these stocks.
All links are directed to Lord Abbett's website.
The historical data are for illustrative purposes only, do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Investors may experience different results. Due to market volatility, the market may not perform in a similar manner in the future.
Past performance is no guarantee of future results. Current performance may be higher or lower than the performance data quoted. All indexes are unmanaged and do not reflect reinvestment of dividends and distributions, deduction of management fees, or operating expenses. An investor cannot invest directly in an index.
Investors should consult with a financial advisor on the strategy best for them based on their individual goals, risk tolerance, and investing time horizon.
Neither diversification nor asset allocation can guarantee a profit or protect against loss in declining markets.
A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. The value of investments in fixed-income securities will change as interest rates fluctuate. As interest rates fall, the prices of debt securities tend to rise, and as interest rates rise, the prices of debt securities tend to fall. Investments in high-yield securities (sometimes called junk bonds) carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Income from municipal securities may be subject to the alternative minimum tax. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. No investing strategy can overcome all market volatility or guarantee future results.
Foreign securities generally pose greater risk than domestic securities, including greater price fluctuations and higher transaction costs. Foreign investments also may be affected by changes in currency rates or currency controls. With respect to certain foreign countries, there is a possibility of nationalization, expropriation, or confiscatory taxation, imposition of withholding or other taxes, and political or social instability that could affect investments in those countries. The securities markets of emerging countries tend to be less liquid, to be especially subject to greater price volatility, to have a smaller market capitalization, and to have less government regulation, and may not be subject to as extensive and frequent accounting, financial, and other reporting requirements as securities issued in more developed countries. Further, investing in the securities of issuers located in certain emerging countries may present a greater risk of loss resulting from problems in security registration and custody or substantial economic or political disruptions. Foreign currency exchange rates may fluctuate significantly over short periods of time. They generally are determined by supply and demand in the foreign exchange markets and relative merits of investments in different countries, actual or perceived changes in interest rates, and other complex factors. Currency exchange rates also can be affected unpredictably by intervention (or the failure to intervene) by U.S. or foreign governments or central banks, or by currency controls or political developments.
While municipal bonds are backed by municipalities, U.S. government securities, such as U.S. Treasury bills, are considered less risky since they are backed by the U.S. government. High-yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities.
Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements.
The median forward P/E ratio is the middle point of P/E ratios based on future earnings estimates.
Standard Deviation is a statistical measurement of the range of a fund's total returns. In general, a higher standard deviation means greater volatility.
Current yield is calculated by dividing annual investment income by the current price of an asset.
Taxable equivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of a tax-free municipal bond. It does not reflect state and local income taxes or the alternative minimum tax, if any and will vary based on each investor's tax bracket.
The credit quality ratings of the securities in a portfolio are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from AAA (highest) to D (lowest). Bonds rated BBB or above are considered investment grade. Credit ratings BB and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities. Credit quality distributions breakdown is not an S&P credit rating or an opinion of S&P as to the creditworthiness of the portfolio.
The S&P 500® Index is a market capitalization-weighted index of common stocks.
The S&P 500® Index Excluding Financials is a subset of the S&P 500 Index that excludes the financial sector.
The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.