Stock market dividends have long played an important role in the portfolios of investors, but their appeal with income-seeking investors has rarely been stronger in today’s slow growth economic environment marked by persistently low interest rates.
In the years leading up to the financial crisis, government bonds offered better yields than stocks, but more recently that relationship has been flipped on its head.
Dividends paid out by publicly-traded companies now yield more than government bonds in all major markets including Canada where the advantage favouring dividends is about as large as it’s ever been at just south of two per cent.
We believe these higher yields may persist and continue to support dividend stocks as long as interest rates continue to plumb to record lows globally. In all likelihood, this is the reality facing investors even if the U.S. Federal Reserve pulls the trigger on another rate hike later this year.
The Fed is in no rush to raise rates aggressively at a time when several of its global central bank counterparts are experimenting with negative interest rate policies in an attempt to kickstart their economies.
The Bank of Canada is also unlikely to raise rates anytime soon. The domestic economy is still absorbing the effects of a lower oil price and it is hoped that lower interest rates and a lower currency will allow the non-energy sectors of the Canadian economy to pick up some of the void left behind by the energy sector.
While dividend stocks remain a valuable source of income in today’s low interest rate environment, investors might consider focusing more on companies that offer a solid but growing dividend, rather than those simply offering the highest yield.
Dividend growth stocks are typically supported by quality companies that have strong balance sheets and positive trends in free cash flow and earnings that are needed to provide regular dividend hikes. As a result, they have historically shown resilience in down markets and may mitigate some of the volatility felt in the broader market.
At the same time, stocks with a history of dividend growth have tended to outperform in a rising rate environment. That means, they may hold up better than some of the higher yielding stocks found in rate-sensitive sectors like utilities or real estate that are potentially more susceptible to losses when the U.S. Federal Reserve starts increasing its key lending rate again.
Over the past five years, Canadian dividend growth strategies such as the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ) have very modestly outstripped the performance of the broader S&P/TSX Composite Index while also delivering slightly less volatility, according to BlackRock research.
Notably, dividend growth strategies are not any more expensive than the broader Canadian equity market and may remain a good opportunity to potentially generate a sizeable boost to a portfolio’s overall yield.
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