Dividend Focus or Sector Skew

With 2024 winding down, we have officially reached forecast season. That time of year when pundits assess not just how the broad market will likely do, but which corners of the market are likely to lead. We will, of course, share our view in the coming weeks, once we have dotted our Is and crossed our Ts. But in the meantime, we think it can be helpful to assess some of headlines’ claims not on whether they are right or wrong, but whether their underpinning is sound. In that vein, let us explore why calls for high-dividend stocks to lead have a shaky foundation.

The argument for dividend payers’ ascension largely amounts to claiming their leadership is due after a fallow stretch. Because they haven’t done so hot, it is time for them to be hot. Now, we award some points for the acknowledgment that leadership rotates and every category has its day in the sun as well as the rain, but nothing here is a timing tool. There is no preset amount or duration of category laggardship that makes leadership automatic. Shifts are irregular and, in our experience, often more of a gradual, three steps forward two steps back kind of thing. Not a switch markets flip decisively with a degree of predictability.

Moreover, the performance comparisons underpinning this thesis strike us as suspect. One article making the rounds Tuesday compared year-to-date returns for the S&P 500 Index and the S&P 500 Dividend Aristocrats. The Dividend Aristocrats’ returns, to date, are a smidge less than half the S&P 500’s. Yet this isn’t exactly the fairest comparison. The Dividend Aristocrats index consists of “S&P 500 companies that have increased dividends every year for the last 25 consecutive years.”^[i] That is a long horizon, and it doesn’t guarantee inclusion of today’s top dividend payers. It automatically excludes companies born this century, as well as companies that, for whatever reason, might have started paying dividends less than 25 years ago. Hence, it excludes all of the so-called Magnificent Seven stocks, even though several pay dividends. We aren’t quibbling with the inclusion criteria, but we don’t think it is quite fair to compare the two indexes and conclude dividend payers are getting left in the dust. Not when the blind spots are so glaring.

Another problem: The S&P 500 is a market cap-weighted index, while the Dividend Aristocrats is equal-weighted. The former has about 500 companies, each weighted according to its market capitalization (total value of all outstanding shares) as a percentage of total index market cap. The latter has 66 companies, each with equal weighting. This, plus the inclusion criteria, creates some big sector-weight divergences. Tech represented 31.3% of the S&P 500 at November’s end.^[ii] But in the Dividend Aristocrats, it was just 3.1%—two companies.^[iii] Communication Services, home to some former Tech firms, has no presence. Consumer Staples and Industrials comprise nearly half the Dividend Aristocrats but just 14.4% of the S&P 500.^[iv] We have a strong hunch that the Dividend Aristocrats’ underperformance is more about sector and style than rampant anti-dividend sentiment.

Yes, even the market-cap weighted MSCI USA High Dividend Yield Index has lagged the MSCI USA—a fairer comparison.^[v] But the universe of high-dividend stocks still is far smaller and the sector weights differ markedly.  

Which brings us to our last point. High dividend payers tend to concentrate in certain sectors. Consumer Staples and Industrials, as well as Financials and Health Care. These sectors aren’t a monolithic bloc, and they will lead and lag one another at times. In our view, it is less about whether “high dividend” stocks do well than whether the sectors themselves are poised to lead or lag for clear, fundamental reasons—not just hope that investors will suddenly start bidding dividend payers higher.

And this is all before we get to the flaws inherent in chasing dividends for their yield alone. So may we offer a suggestion? Instead of viewing dividend payers as a bloc, recognize that while they concentrate most in certain sectors, they kind of run the gamut. Some sectors’ performance drivers will depend more on their dividend yield. Utilities comes to mind, for example. So does Real Estate, with its heavy REIT exposure. Both are interest rate-sensitive, in large part because of their cash payouts (but also because both tend to be quite leveraged). But in other categories, the dividend is just one factor in an overall value bent, and relative returns depend more on whether markets prefer companies gunning for long-term growth. Point being, it is all deeper and more complicated than whether Widgets ‘R’ Us pays a dividend.

Don’t get us wrong, we like dividends just fine. We just think it is important to consider them through an objective, accurate lens—as part of an investment’s total return. And whatever you think high dividend-paying sectors will do next year, we just don’t think the past performance of two differently constructed indexes should factor into your reasoning.