Dividend stocks have a lot to offer investors.
They are often safer than the market as a whole; they often provide regular – sometimes rising – income and offer a chance for capital appreciation.
The tradeoff for this safety is that dividend stocks frequently generate returns below those of growth stocks. Dividends are common for companies in low-growth businesses, such as utilities, consumer staples, and financial services.
It’s a risk-reward equation: the higher your risk tolerance, the higher your returns can be. And vice versa.
But dividend stocks still represent an important element of a diversified portfolio, many experts say.
“Going back to 1960, 85% of the cumulative total return of the S&P 500 index can be attributed to reinvested dividends and the power of compounding,” according to a report from Hartford Funds.
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'Dividend stocks are like Volvos'
“Dividend-paying stocks are like the Volvos of the investing world. They’re not fancy at first glance, but they have a lot going for them when you look deeper under the hood.”
Volvos, of course, are known for their simple design and emphasis on safety.
Dividends are nice. But remember, higher dividend yields don’t necessarily mean a stronger stock or company.
Dividend yields equal the annual dividend divided by the current share price. A soaring dividend yield could mean a plunging share price caused by a company's financial problems.
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Experts say that dividend investors should look for companies that regularly raise their dividends, which often reflects sound financial management and growing revenue and profit. The worst companies aren't likely to be positioned to continuously increase their dividend payments.
Also, companies that raised or began to pay a dividend have seen the highest returns relative to other stocks since 1973 — with significantly less volatility, according to Hartford Funds.
The average annual return for these dividend stocks was 10.19% during that period, compared with 7.72% for the equal-weighted S&P 500 index.
Analysts share view on dividend stocks
Wolfe Research analysts are bullish on dividend stocks, too. “High dividend growth has been the top performing dividend theme in 2024 year to date,” they wrote in a May 20 commentary.
“Our favorite strategy is the combination of high dividend growth and high free-cash-flow yield, which outperformed by [5 percentage points] historically.”
Among recognizable companies in that Wolfe strategy (in random order) are:
- Online retailer eBay (EBAY) ,
- Entertainment company Fox (FOXA) ,
- Health-care titan Johnson & Johnson (JNJ) ,
- Biotechnology giant Amgen (AMGN) , and
- Archer-Daniels-Midland (ADM) , which processes agricultural commodities.
EBay’s dividend increased a combined 23% over the past two years. The company’s free-cash-flow yield climbed 70% last year to 11.1%, according to Finbox, an investment information service.
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Wolfe also put together a list of companies that don’t currently pay a dividend but have the potential to do so soon.
These companies have strong free-cash-flow yields, are currently executing stock buybacks and aren’t highly leveraged. The list includes (again in random order):
- Home-rental platform Airbnb (ABNB) ,
- Auto-parts retailer AutoZone (AZO) ,
- Financial-services stalwart PayPal (PYPL) ,
- Online securities brokerage Robinhood Markets (HOOD) , and
- Steelmaker Cleveland Cliffs (CLF) .
Airbnb’s cash-flow yield totaled 4.9% in 2023, down from 6.1% in 2022, but up from 1.7% in 2021, according to Finbox.
The company bought back the equivalent of 5% of its market capitalization in the past 12 months, according to Wolfe.
Its leverage stands at negative 2.2. That leverage constitutes net debt (cash) divided by estimated 2024 earnings before interest, taxes, depreciation, amortization and restructuring/rental costs.
Morningstar’s take on eBay and Airbnb
Airbnb and eBay are two of the most intriguing stocks on the list.
Morningstar analyst Sean Dunlop assigns eBay a narrow moat, meaning he sees it having competitive advantages that will last at least 10 years. He puts fair value for the stock at $54. It traded at $53.70 Tuesday.
“We take a positive view of eBay's strategic framework,” Dunlop wrote. “After divesting a number of noncore segments, its marketplace looks similar to the vibrant platform of the early 2000s.”
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As for Airbnb, Morningstar analyst Dan Wasiolek gives the company a narrow moat. He puts fair value for the stock at $139. It traded at $147 Tuesday.
“Airbnb's global online travel agency position will strengthen over the next decade, driven by a leading alternative accommodation network,” Wasiolek wrote.
This network advantage will benefit from investment in artificial intelligence and expansion into the experiences segment and international markets, he said.
Given that both stocks already trade near or above Morningstar's fair value target, investors may want to wait for a pullback. After all, neither has committed to paying a dividend yet.
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The author of this story owns shares of Johnson & Johnson, Amgen and PayPal.
