Dividend investing is a conservative way to approach equities. One common trap that many investors fall into is solely focusing on dividend yield alone. The chart below shows the relative performance since 2015 of S&P 500 constituents.
The S&P 500 constituents were categorized into three groups:
1. Greater than 3% yielders
2. Less than 3% yielders
3. Non-Payers
If the performance line is above the 0% axis, that category is outperforming, if below 0% the category is underperforming.
Source: Factset Research, Brentview Investment Management
Since 2015, investors focusing on companies with greater than 3%, have likely experienced negative relative performance to the S&P 500 index, in short, they have underperformed. Conversely, the less than 3% cohort has outperformed the S&P500. Even more impressive is the less than 3% cohort participated alongside non-payers, a category dominated by information technology and consumer discretionary companies.
In light of these historical results, an investor has two takeaways. First, stock selection matters and second diversify exposure by dividend yield.
Selection matters
Several dynamics will drive the performance of a dividend paying equity. However, unlike any other equity, fundamentals will matter. By focusing solely on dividend yield, an investor runs the risk of buying stagnant companies with no growth prospects. Worst yet, an investor can end up buying a company with an enticing yield that goes on to cut or eliminate their dividend. These “value traps” can be destructive to investment capital. On occasion, an investor can find a turnaround candidate with attractive yield, however, those opportunities are difficult to identify. In short, there is less room for error in higher yielders as the elevated dividend yield is already telling you something.
Diversify by yield
Dividend yield and dividend growth are generally inverse. The graph below generally depicts this tradeoff for illustration purposes. In short, higher yielders will have lower dividend growth, and lower yielders have higher dividend growth.
A portfolio that is solely tilted towards dividend yield forgoes dividend growth. Conversely a portfolio focused solely on dividend growth gives up dividend yield. Ultimately striking a balance between these two extremes allows an investor to generate yield along with dividend growth.
Conclusion
Investors looking to maximize dividend yield should understand the risks of their approach. The allure of a high yield is a non-verbal cue. The likelihood of buying a company on the precipice of a dividend cut or underperforming value trap increases greatly. Conversely, dividend growth investing is a conservative approach with yield for today but also growth for tomorrow. Disciplined well run companies with excess cash flow reward shareholders with growing dividends. Focusing on companies with the fundamental strength to financially support future dividend growth requires attention on selecting the right companies. Additionally, when building a portfolio, diversification across varying yields will allow for a cross section of companies with varying levels of dividend growth rates. When taken into consideration with sector exposure, the overall portfolio can be positioned for total return and resiliency through more challenging markets.
ABOUT BRENTVIEW
Brentview Investment Management, LLC is an investment adviser registered with the Securities Exchange Commission (SEC) under the Investment Advisers Act of 1940 and is based in Northfield, Illinois. The boutique money management firm is employee owned and has a singular focus on dividend growth investing. Our investment approach incorporates the timeless principle of fundamental research to determine stock selection and maintain conviction. Brentview Investment Management, LLC is a Minority Business Enterprise (MBE) certified with the National Minority Supplier Development Council. Certifications are renewed annually.
Registration with the SEC does not in any way constitute an endorsement of the investment adviser’s skill or expertise. Past results are no guarantee of future results, and no representation is made that a client will or is likely to achieve positive returns, avoid losses, or experience returns similar to those shown or experienced in the past.
To learn more about Brentview, visit www.brentviewim.com/
This commentary reflects the views of the Brentview Investment Management and is subject to change as market and other conditions warrant. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, sector, or index. The commentary should not be seen as a solicitation or offer to buy or sell any securities. The advisor (Brentview Investment Management, LLC), and their employees and clients, may hold or trade the securities mentioned in this commentary. Diversification does not guarantee a profit or eliminate the risk of a loss. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS.