What a difference a year makes. Around this time last in 2020, we warned about the difficulty of finding cheap dividend stocks. Markets were strong but there were concerns, with investors preoccupied with fears over Brexit, rising U.S.–China trade tensions and slowing earnings growth.
At that time, dividend stocks were seen to offer some stability amid all that turbulence. Yet, few could have anticipated the havoc that COVID-19 would bring into every facet of our lives. Now, more than a year since the deadly virus was identified in Wuhan, China, around the world it continues to sicken and kill people of all ages, upend businesses and disrupt investment plans.
Still, for all of the market volatility of 2020, if you were a patient investor and had a balanced portfolio, there is a good chance you finished the year more or less where you started—or perhaps even a bit ahead. That’s remarkable, given major markets like the S&P/TSX Composite and the S&P 500 both lost more than a third of their value in the early months of the pandemic.
So, did dividend stocks provide that expected buffer? Not as much as anyone would have liked. “Many dividend stocks proved not to be as defensive during the market downturn as most would have thought,” says Don Newman, a portfolio manager at Fidelity Investments Canada who oversees the $2.2-billion Fidelity Dividend Plus Fund. Put simply, companies experienced a dramatic shift in their business in 2020, unlike in a typical recession, where economies gradually slow down.
“This challenged many companies’ balance sheets and even led to dividend cuts for those with too much debt,” Newman says.
As most of the market retreated, a subset of companies, particularly those focused on video calls, digitization and nesting, with the likes of home furnishing and renovations, benefitted from the shift to work from home. Tech was the big winner, particularly on the tech-heavy Nasdaq, which is made up of mostly non-dividend payers, says Oscar Belaiche, who helps oversee $18 billion as the head of equity income team at Dynamic Funds.
There’s still a strong case for dividend stocks
While 2020 was a difficult year for dividend investing, there is a strong case to have them in your portfolio now. As Belaiche notes, fixed-income investments aren’t as attractive right now, especially if you’re looking to create an income stream. The spread between dividend yields and bond yields is close to the highest it has ever been in Canada. That, coupled with the dividend tax credit and the chance for capital appreciation, makes dividend-paying companies more attractive over other income-producing investments.
To illustrate, Belaiche offers up the following example: If you want to generate $40,000 a year pre-tax and are earning only 0.25% in a high-interest savings account, then you’d need to have a portfolio of $16 million. With a dividend yield of 5%, you’d need only $800,000 to earn the equivalent, he explains.