Diversifying with dividends


Gargi Pal Chaudhuri Jun 27, 2022

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

Figure 1: Dividend stocks outperformed the broader market as rates have risen

Line chart showing the outperformance year-to-date of the S&P 500 High Dividend Total Return Index as represented by the yellow line relative to the S&P 500 Index as represented by the red line.

Source: iShares Investment Strategy, Bloomberg, S&P 500 High Dividend Total Return Index and S&P 500 Index performance data rebased to 100 from December 31, 2021 to May 24, 2022. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Chart description: Line chart showing the outperformance year-to-date of the S&P 500 High Dividend Total Return Index as represented by the yellow line relative to the S&P 500 Index as represented by the red line.


INCOME

INCOME

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

DIVERSIFICATION

DIVERSIFICATION

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.

VALUE

VALUE

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

QUALITY

QUALITY

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

Figure 2: Free cash flow yield of the S&P 500 High Dividend Index exceeds that of the S&P 500 Index

Line chart showing the free cash flow yield of the S&P 500 High Dividend Total Return Index as represented by the green line being higher than the free cash flow yield of the S&P 500 Index as represented by the pink line in most years since 2016.

Source: iShares Investment Strategy, Bloomberg, S&P 500 High Dividend Total Return Index and S&P 500 Index from December 31, 2015 to December 31, 2021. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Chart description: Line chart showing the free cash flow yield of the S&P 500 High Dividend Total Return Index as represented by the green line being higher than the free cash flow yield of the S&P 500 Index as represented by the pink line in most years since 2016.


CONCLUSION

CONCLUSION

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.

Gargi Pal Chaudhuri

Gargi Pal Chaudhuri

Head of iShares Investment Strategy Americas at BlackRock

Eric Legunn, CFA

Institutional Product Consultant

Contributor

Arjun Kapur

Investment Strategist

Contributor