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Dividend Stocks Find Favor in Fractious Market

22 October 2014 in Trading Ideas

It’s doubtful that many investors are in a Zen state these days.

Even with stocks clawing slightly higher, the market showcased another volatile week last week – and another one to end on the downside. For the fourth straight week, stocks finished lower than where they started; that hasn’t happened since August 2011.

During that past month, the S&P 500 has fallen more than 6%.

As Barron’s explained this past weekend, the potential spread of Ebola and slowing global economic growth continue to dominate a long laundry list of investor concerns. This was highlighted on Wednesday when Treasury yields temporarily fell below 2% and bond prices soared.1

For now, it seems, volatility is back, and as Fort Pitt Capital Group senior equity analyst Kim Forrest told Barron’s, “People who once thought they had risk tolerance are finding out they don’t.”

With volatility here to possibly stay for a while, the question becomes whether this four-week selloff is the end of it. Opinions vary, but many analysts seem reluctant to call the bottom. As one veteran trader told Barron’s about last week’s finish, “It was a low, but I’m not sure it was the low.”

Such times have often marked the signal for investors to turn to defensive investing strategies — this could mean rotating funds into bonds or into more traditionally conservative equity sectors.

It also can mean a look at dividend-paying stocks, which can provide some income (barring an elimination of the payout) even in the face of depreciating stock prices.

Two dividend-focused motifs, for example, have outperformed the S&P 500 during this recent downturn in stocks. In the past month, the High-Yield Dividends motif has fallen 0.3%, while the Growing Dividends motif is off 1.4%. During that same time period, the S&P 500 has decreased 3.7%%.

Over the past six months, the High-Yield Dividends motif has gained 2.7%, while the Growing Dividends motif is up 2.1%. The S&P 500 has risen 2.2% in that same period.

This goodwill from investors isn’t necessarily a coincidence. As Lauren Gensler at Forbes.com recently wrote, dividend stocks are historically less volatile than non-dividend stocks, and as long as a company continues its payout, investors have an opportunity to build a cash cushion during rocky markets.2

“For long-term investors, dividends can make up approximately 40-50% of your total return, if you re-invest,” Jim Swanson, MFS Chief Investment Strategist, told Forbes. “Knowing that, you can remain calm during erratic market periods,” he says.

Dividends are also 70% less volatile than earnings over time, notes Swanson, so they can often remain stable even as companies face external pressures and headwinds. No one wants to have to tell shareholders they are decreasing or eliminating a dividend, he says.

That’s why companies that issue dividends tend to be big and established, with healthy balance sheets equipped to ride out some volatility. Roughly 85% of the S&P 500 and all 30 of the Dow Jones Industrial Average companies pay dividends.

That doesn’t mean all dividend-paying stocks are created equal.

Gensler noted that telecom and utility stocks have traditionally paid the biggest dividends, with a 6% average yield from telecom stocks and a 3.5% yield from utilities, according to financial research firm Markit cited by Forbes.com.

However, McMahon urges investors to remember that dividend strategies shouldn’t be based on the highest yield but on companies with strong fundamentals and the most consistent history of cash flow generation.

Investors should also stay aware of signs of higher volatility and market risks. While not intended, companies can reduce dividends to help ride out worsening conditions on their balance sheets. It’s a good idea to have a selling price point and exit strategy in place.

1Vito J. Racanelli, “A Rocky Week Ends With a Rebound,” barrons.com, Oct. 18, 2014.

2Lauren Gensler, “Why Dividend Stocks Are A Good Defense In A Choppy Market,” forbes.com, Oct. 16, 2014, http://www.forbes.com/sites/laurengensler/2014/10/16/dividend-stocks-market-volatility/, (accessed Oct. 19, 2014).