Dividend-paying stocks are still unloved. A rotation back into higher-yielding ones should begin soon.
Venetian Macao resort and casino in China, owned by Las Vegas Sands.
Sometimes, it’s a good idea even for dividend investors to swim in front of the sharks.
BofA Securities recently took a look at the holdings of active managers—the big fish controlling trillions of dollars of assets—and noticed a few things that smaller, more nimble investors can use to their advantage. One discovery: Dividend-paying stocks are still unloved, and a rotation back into higher-yielding stocks should begin soon.
The market has shunned dividends for a while. The Morningstar U.S. High Dividend Yield Index has underperformed Morningstar’s U.S. Market Index by about 30 percentage points over the past five years. The result: Dividends, which historically have accounted for some 40% of total stock returns over the past century-plus, have accounted for closer to 15% of total returns over the past decade.
That’s about to change. “The Fed has embarked on rate cuts with short rates slated to decline by about two percentage points in the next cycle,” wrote BofA equity and quant strategist Savita Subramanian in a recent report. “Retiree cash moved into money-market funds in 2022, but we think will likely flow into asset classes with higher real yields like higher dividend-yielding equities.”
Dividend stocks are easy to access. Investors can buy exchange-traded funds such as Schwab US Dividend Equity (ticker: SCHD), Vanguard Dividend Appreciation (VIG), or iShares U.S. Dividend & Buyback (DIVB). They can also look for attractive-yielding stocks that are under-owned by active managers. That way, smaller investors can get a little extra performance as higher demand from institutional investors drives up share prices.
Institutional investors own about 70% of JPMorgan Chase, gold miner Newmont, materials maker DuPont de Nemours, energy giant Exxon Mobil, and defense contractor Lockheed Martin, well below the 90% that they own for the typical stock in theS&P 500 index, according to Bloomberg. Those five stocks yield an average of 2.3% while paying out less than 50% of net income as dividends, a safe level. Wall Street likes them too. The average Buy-rating ratio for the five is about 63%, while the average Buy-rating ratio for S&P 500 stocks is about 55%.
Catching institutional investors unawares can have its perks. Long-only asset managers were unprepared for the China rally catalyzed by new government stimulus, says Subramanian. Through Wednesday, the Invesco Golden Dragon China ETF (PGJ) was up 40% over the past month. Gains have left stocks overbought—a technical term that essentially means shares have gone up a lot, fast, making a pullback more likely.
The growing participation of institutional investors, though, means the rally in Chinese stocks can continue longer than many investors expect. Shares are still well off their all time highs, points out CappThesis founder Frank Cappelleri, so any pullback is an opportunity to buy the dip for the foreseeable future.
Income-oriented investors have some options to play the China trade. U.S-listed shares of Alibaba Group Holding, Tencent Music Entertainment, shipper ZTO Express, and online seller JD.com yield an average of 1.3% while paying out less than 30% of net income as dividends. Shares are down an average of 55% off all-time highs, while the average Buy-rating ratio for the quartet is 84%.
Investors can also look at shares of U.S. companies doing a lot of business in China. Subramanian highlighted luxury brand Tapestry, Merck, chip makers Qualcomm and NXP Semiconductor, and casino operator Las Vegas Sands. Those five generate an average of about 37% of sales in China, yield an average of 2.2%, and pay out about 40% net income as dividends. The average Buy-rating ratio for the five is about 75%.
Lower interest rates and Chinese growth acceleration look like safe bets heading into 2025. Both things leave dividend-hungry investors with plenty of options to capitalize on the trends—while getting paid along the way.
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