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Turn To Dividend-Paying Stocks If Equity Bull Rally Really Is Petering Out - Bank Of Singapore

Tom Burroughes

19 April 2017

Equities that pay dividends look robust as a source of returns even though the post-November bounce in US stocks has lost steam, according to . 

“`Trump trades’ have run out of steam lately, amid growing market scepticism about the likelihood of significant near-term US tax reform, deregulation and infrastructure spending,” James Cheo, investment strategist at the private bank, said in a note.

His comment comes as stocks, which rose in the aftermath of the November 2016 election win of Donald Trump in the US, have struggled to post further major gains. The MSCI World Index of developed countries’ equities shows total returns - capital growth plus reinvested dividends - of 6.02 per cent from the start of 2017; the MSCI North America shows total returns of 5.53 per cent.

Cheo notes that dividend-paying stocks, while they vary, tend to be strong firms built to withstand market gyrations, boasting strong balance sheets and ample free cashflow to support dividend payouts.

There are already investor concerns that the US equity bull run, which has been in place since 2009 - an unusually long period - is due to end, particularly if there are more increases in US interest rates this year. In March, Bank of America Merrill Lynch’s monthly global poll of investors showed that a record number of them (a net balance of 34 per cent) said equities are expensive, which is the highest such view in 17 years (around the height of the dotcom boom); the US equity market was seen by a net 81 per cent of respondents as the most overvalued region, with emerging markets (44 per cent) and eurozone equities (net 23 per cent) regarded as undervalued.

In such an environment, the “bond-like” characteristics of dividend-paying firms are worth attention, Cheo said.

“As the US bull market matures, some shareholder friendly policies would likely slow down - especially M&A activity and share buybacks. A company’s commitment to paying dividends has remained a priority and those growing their dividends are likely to continue to attract investors’ interest. Stocks that can consistently grow their dividends tend to perform well and exhibit less volatility in a rising rate environment, while high yielding dividends, often considered `bond-like proxies,’ are more vulnerable (due to their high debt levels) and have followed bond performance when rates rise,” he said.

He argued that historical data shows that dividend-growing stocks have higher returns but lower volatility when compared to investing in the market benchmark.

“Over the long-term, investing in dividend growers is a better way to build wealth compared to just investing in the market. An initial $100 investment in dividend-growing stocks back in 1990 would grow to $1,975, compared to the same investment in S&P 500 (even considering the reinvestment of dividends from the S&P 500) growing to $1,224,” Cheo continued. 

A wide, deep “moat”
Describing his approach to finding the most robust dividend payers, Cheo said he and his colleagues imposed a number of metrics, such as market capitalisation and the ratio of net/debt to earnings before interest, taxation, depreciation and amortisation, to find the strongest names; Bank of Singapore also only held firms with a market capitalisation of at least $10 billion. It also focused on global telecoms, and European defensive stocks such as in healthcare, consumer staples and utilities. “Telecoms, as well as healthcare, is our preferred sector within the defensive end of our barbell sector strategy. With the concern of political risks in Europe, we prefer European companies with Wide moat rating - that is, companies with sustainable long-term competitive advantage,” Cheo said.

A “moat” is a term - originally coined by US investment guru Warren Buffett - describing the competitive advantage one firm has over other companies in the same industry. The wider the “moat”, the larger the competitive advantage of a company is. A well-known brand name, strong pricing power and large power of market demand can create a barrier to entry towards wannabe competitors.