Beware, investors: Dividend 'golden age' may be ending

One of the best places to find income in a yield-thirsty world has been the stock market, but the "golden age" may be drawing to a close.

Dividends historically have generated about one-third of the market's total return, and many corporations managed to boost their payouts at a time when yields have flattened elsewhere. Some stocks yield more than a lot of bonds, including 10-year Treasury notes, which pay just 1.55%.

However, unless profit growth kicks into higher gear, Corporate America might have trouble adding to these payouts. "The golden age of dividend growth is over," warned Josh Peters, a portfolio manager at Morningstar, in a recent commentary.

He and others have raised cautionary flags that the rising-dividend trend of recent years has been slowing. Blue-chip companies in the Standard & Poor's 500 index have increased dividends, adjusted for inflation, by an average of 5.9% annually over the past 12 years — a pace that Peters called "extraordinary." That stretch includes the dividend-desert stretch from  late 2008 to early 2010, when many companies slashed their payments amid the recession.

Dividends rebounded over the next several years, but the more recent trend has been toward smaller increases. Dividends rose just 4.6% in the first quarter. Peters called it "the weakest advance in nearly six years."

Part of that reflects oil-price weakness that led to cuts in the energy sector. But corporations in general have had problems lately boosting  profits. Corporate earnings per share are  down since peaking in the third quarter of 2014. Yet over the same span, dividends per share paid by S&P 500 companies have risen 14%, Peters noted.

That means corporations have been paying out a rising slice of each dollar in profit as dividends. These dividend-payout ratios have risen to about 50% — a relatively high figure, at least in the context of recent years. "I strongly suspect that payout ratios will now constrain the rate of dividend growth,"  Peters wrote.

In contrast to the dismal rates of interest paid on bonds and bank deposit accounts, dividends have been an oasis for income-parched investors. However, corporations don't like to go overboard without payouts. Dividends represent a significant financial commitment — cuts are viewed with alarm — and thus can be justified only if a corporation's underlying cash flow and business conditions are growing or at least stable.

For investors, it makes sense to kick the tires and be cautious when assessing dividends. Rather than simply buying the highest-yielding stocks, it's smarter to ferret out corporations that have demonstrated an ability to increase their dividends over time. For example, HCP, AT&T, Chevron, Caterpillar and several utilities and real estate investment trusts or REITs are among the top holdings of the S&P High Yield Dividend Aristocrat, an exchange-traded fund that invests in companies that have boosted their dividends each year for at least 25 straight years.

But in a low-profit environment, dividend increases could become more elusive. Vanguard in late July  closed its Dividend Growth Fund to new investors, citing concern that high cash flows coming in from investors could dilute the portfolio's performance. Like S&P's Aristocrat ETF, the Vanguard fund invests in corporations that have shown a willingness and ability to boost their dividends over time.

Neal Van Zutphen, a dividend-focused investment adviser at Intrinsic Wealth Counsel in Tempe, Ariz., said he's not yet concerned about the potential impact of stagnant profit growth on yields. Many dividend-paying corporations are sitting on piles of cash, and many have refinanced debt at low interest rates, providing an additional cushion, he noted. Also, hundreds of firms operate in industries like telecom, banking and household products that see steady consumer demand year-round, regardless of economic conditions.

In addition to Aristocrat companies that have boosted their dividends for 25-plus years, plenty of other corporations have been paying dividends for less time but seem poised for steady increases, said Van Zutphen, citing Cisco Systems and its 3% yield as an example.  "Many companies still have room to growth their dividends," he said.

In a S&P Dow Jones Indices cited "inconclusive evidence as to whether dividend-paying firms are better  investment options" than stocks that don't pay dividends. However, the report did note that dividends tend to support stock prices, making high-yielding companies less vulnerable to steep market downturns.

The report also underscored another important feature of dividend investing, related to not spending dividends but, rather, reinvesting them in additional shares. If you had invested $1 in S&P 500 stocks at the start of 1930 and held your investment through 2012, your initial stake would be worth about $66.50, reflecting capital appreciation only, according to the report. But if you also had reinvested all dividends along the way, your original $1 would have swelled to $1,832.

In short, dividends can be a valuable piece of the investment puzzle, helping stocks outperform bonds, as has been the case historically. But to the extent dividend yields stagnate or drop off, that could be bad news. How things play out could ultimately hinge on whether enough corporations can generate an uptick in profits.

Reach the reporter at russ.wiles@arizonarepublic.com or 602-444-8616.