Drawbacks to a Dividend-First Focus

Pop quiz: What do a Bloomberg piece on office REITs’ recent rebound and a Wall Street Journal look at Utilities stocks’ 2023 troubles have in common? Answer: Both show why a heavy focus on dividends is unwise. In the former, while these securities’ prices may be bouncing, the funds are cutting dividends left and right. And in the latter, Utilities’ “chunky” dividends aren’t enough to entice investors to bid them up … or compensate for falling prices. We like dividends just fine, but we don’t think forming a portfolio around them is a winning approach.

There are times when we are sort of jealous of high dividend stocks. Everyone seems to love them and overlook their flaws. S&P labels the biggest ones “aristocrats,” as if they spend their days at garden parties wearing only the finest linen and hats. Headlines often pitch them as all-around performers. Allegedly, their big yields turbocharge returns in bull markets and cushion the pain during bear markets and recessions. Like a magic tonic, they are good for whatever ails you! Some folks will even completely overlook poor price performance when a stock pays a heavy dividend.

Here is the simple, boring, perhaps maddening truth: High dividend-paying stocks are just stocks. And like all other stocks, they have their time in the sun as well as the rain. Dividend payers fell during last year’s bear market. Not as much as broad markets, but their double-digit swoon was no picnic. Since last October’s low they are lagging, which is about what we would expect given the categories that drive the bear market lower tend to bounce disproportionately, too. Granted, dividend payers are still ahead modestly since January 2022’s highs, but the sector and style concentrations of the high-dividend universe make us skeptical that high-dividend stocks will be this bull market’s big winners.

This is because dividend stocks tend to cluster in value-heavy areas—think Utilities, Financials, Consumer Staples and Health Care. All are unlikely to lead in a bull market where growth stocks do much of the heavy lifting, which we think is the likeliest scenario for the foreseeable future. Furthermore, three of them (Utilities, Staples and Health Care) are traditionally sectors that lag in bull markets. Investors today are looking for the stocks most capable of boosting earnings in a slow-growing global economy—true growth stocks. This has a lot of overlap with Tech stocks, which are 22.5% of the MSCI World Index’s market cap but just 10.3% of the MSCI World High Dividend Index. High-dividend stocks also have less exposure to growthy Consumer Discretionary and a whopping blind spot to the growth-oriented Interactive Media & Services industry within Communication Services. Concentrating in dividend stocks, therefore, amounts to making sector decisions that inadvertently cut against this young bull market’s characteristics.

And that assumes these dividend payers remain high dividend payers. One of the more frustrating things about dividends is that sometimes they go away. Management may elect to stop paying dividends in tough times or if they have a burning capex need. In the Financials sector, dividends are subject to regulators’ whims and can vanish if a bank doesn’t do quite as well on its annual (arbitrary) stress test as the Fed wants. Here, too, elective dividend cuts have happened, with perhaps the most extreme example being 2008’s financial crisis. Those cuts happened as bank stocks got pounded, adding insult to injury.

Again, we aren’t anti-dividend. But we don’t think it should be the sole or even chief factor determining whether you buy. Similarly, we think it is best to focus on your portfolio’s total return—price movement plus dividends—and not obsess over yield. You may have some big dividend payers, and you may leave some others on the table if they don’t fit your sector, industry and style outlooks. Either way, you won’t be limited to the narrow pool of high-dividend stocks, giving you more opportunities to diversify.