Companies that pay dividends, and in many cases are raising them, are attracting strong attention amid an otherwise unappetizing market.
But a healthy dividend doesn’t necessarily mean the company issuing it is in the best shape, says Standard & Poor’s equity analyst Todd Rosenbluth.
“You shouldn’t just pick a stock that pays a dividend, but pick one that has good prospects and that pays dividend,” Rosenbluth said. “There are alternatives out there.”
Indeed, in the second quarter of 2011, 444 public companies raised their dividends, up from 335 a year earlier, according to S&P. Meanwhile, just 21 companies lowered their payouts during the quarter.
Dividends remain a key focus of cash flow for large-cap companies, which are sitting on record amounts of cash. At the same time, low interest rates have made bonds less attractive to investors seeking yield.
Investors seeking above-average yield should look at telecom services (average yield of 5.4% at the end of July), utilities (4.3%), consumer staples (3.0%) and industrials (2.4%), according to Rosenbluth.
Companies that pay and raise dividends can be signaling stability and confidence in their futures, notes Rosenbluth. What’s more, in times of volatility, dividend paying stocks “tend to hold up better because the dividend provides some downside support to shares,” he adds. Alternatively, dividends may be misleading.
Based on an S&P analysis, companies like AT&T and General Electric are among those with strong business prospects as well as healthy yields, he notes. On the other hand, those whose yields are at least 2.5% but are unattractive due to fundamental weakness or high stock prices include Safeway and energy provider NiSource, according to S&P.
“We think the stocks will actually decline in value over the next 12 months,” Rosenbluth said.
Through the month of July and the beginning of August, the S&P 500 Index was down 0.3% for the year due to macroeconomic concerns. Yet the total return, factoring in the benefits of dividends, is 0.8%. Rosenbluth points to exchange-traded funds as a cost-efficient way to gain exposure to a diverse basket of dividend payers.
Using its MarketScope Advisor analytical tool, S&P found numerous high-ranking stocks yielding more than the S&P 500 Index's 2.0% within the four highest yield sectors of the market.
The picks include AT&T: S&P expects gains in wireless and broadband to support operating margin expansion for the company. And its analysts believe the shares trade at an unwarranted price-to-earnings discount to its peers. The company’s recent dividend yield was 5.8%.
United Parcel Service should benefit from its ability to push additional volumes through its transportation network, according to S&P. And its shares are supported by a buyback program. What’s more, UPS has a history of increasing its dividend, which recently yielded 3%, S&P notes.
In the ETF arena, S&P points to WisdomTree Total Dividend Fund and Vanguard High Dividend Yield Index Fund.