Diversifying with dividends

Amid a challenging market in 2022, investors seeking income, diversification, value, and quality across sectors may find opportunity in dividend stocks. Quality-oriented growth and technology stocks most sensitive to the rise in interest rates this year continue to suffer from tightening financial conditions driven by the Federal Reserve’s current hiking cycle. We see dividend stocks as an alternative source of quality that have generally exhibited outperformance over the broader market year-to-date, as they offer:

• potentially attractive yield,
• compelling valuations, and
• diversified exposure to sectors benefiting from the current macro regime of high inflation and slowing growth. 

Year-to-date, amidst rising interest rates and tightening financial conditions, U.S. dividend ETFs have seen over $30 billion of inflows.¹ Over this period, dividend stocks have outperformed the broader U.S. stock market by over 20% as shown in figure 1.² In fact, dividend stocks have outperformed the broader market on an absolute and annualized basis over the past decade.³

Income-oriented investors may find opportunity in dividend stocks, which have offered more than double the dividend yield relative to the S&P 500, and over 1% more yield than the 10-year Treasury yield.⁴

As investors seek alternative sources of quality, in particular seeking quality outside of the technology sector, dividend stocks offer diversification toward other sectors including utilities, consumer staples, healthcare, and energy.⁵ These particular sectors may benefit from defensive positioning and a focus on commodity exposure.

On a valuation basis, dividend stocks have offered a nearly 40% discount as measured by the price-to-earnings ratio and are also attractive on metrics including price-to-sales, price-to-book value, and price-to-cash flow.⁶

Compared to stocks whose prices reflect expected profits that extend longer into the future, dividend paying stock prices tend to reflect near-term profits. Since rising interest rates can decrease the present value of future cash flows, the outperformance of high dividend yield stocks relative to the broader market suggests an investor preference for near term cash flows. High dividend-paying companies also offer over double the sales per employee of companies representing the broader market and boast a free cash flow yield — the free cash flow per share divided by the current share price — of 5.9% versus 4.7% for the S&P 500.⁷

In the uncertain market environment of 2022, dividend stocks may provide resilience in the face of tightening financial conditions, potentially offering investors income, diversification, value, and quality in a portfolio.