The transformation of the investing landscape since the global financial crisis has required investors with income needs to reconsider their approach. With bond yields lingering near multiyear lows, many investors have shifted their focus to dividend-paying stocks.
But for income-seeking investors whose needs also include a measure of appreciation and a relatively attractive risk profile, the challenges today are more complex. To balance these diverse objectives, consider a multi-asset strategy with a focus on a broadening universe of dividend-paying equities.
Here are some approaches to consider when seeking income, return potential and relatively low volatility:
Target lower yields but faster growth potential
Investors may seek to invest in lower yielding companies that have demonstrated the capacity and commitment to increase dividend payments over time. Dividend growers offer a number of potential advantages. For example, being able to sustainably grow dividends is often an indication that a company can grow earnings over time. A track record of dividend growth can also be an indication of strong capital discipline. Companies that are committed to growing dividends tend to have a rigorous capital allocation process, as they commit to setting aside a portion of earnings for shareholders.
The bottom line for investors: Dividend growers historically have generated higher average returns and lower average volatility than either steady dividend payers or companies that pay no dividends.
In search of fertile ground
Dividend growers: historically strong returns with less volatility
Results are based on the weighted average of total returns in USD (with gross dividend reinvested) of a global universe of companies for the period December 31, 1989, to December 31, 2016. The global universe consisted of the 1,000 largest companies in the S&P BMI Global Indices for North America (50% weight), Europe (25%), Japan (10%) and the 500 largest companies for emerging markets (10%) and Pacific ex Japan (5%) from December 1989 to December 2004; it consisted of the 1,000 largest companies in the MSCI IMI Indices for North America, Europe and Japan and the 500 largest companies for emerging markets and Pacific ex Japan (with the same geographic weighting) starting in January 2005. The universe constituents are rebalanced quarterly. A company was classified as a “dividend payer” if it paid a dividend during the previous 12 months. A company was classified as a “dividend grower” (a subset of payers) if its trailing 12-month dividend per share increased relative to one year earlier. Volatility reflects annualized standard deviation of monthly total returns. Past results are not predictive of results in future periods.
Sources: MJJG (QRA), FactSet, Compustat, Worldscope, MSCI, Capital Group.
Seek yield in nontraditional areas
Where can one find dividend growers? Look in areas of the market that have not traditionally paid dividends, such as information technology and biotechnology. Certain technology companies have become more mature and intelligent about their capital allocation. Previously, these tech companies often had good cash flow, but they worried that paying dividends would give investors a perception that they were past their high-growth phase.
For example, Microsoft has paid out and grown its dividend in recent years. Microsoft has also become a substantially better managed company. It is focusing on its core business, including the Windows operating system and Office suite, which are very cash-generative. It also is having some success in its cloud computing business. In addition, several semiconductor companies, such as Texas Instruments and Intel, have also strongly embraced dividends in recent years.
Although large pharmaceutical companies have long paid dividends, biotechnology firms historically have not. However, a few have initiated dividends as their business models have matured. For biotech firm Amgen, shareholder demand and changes in its business encouraged the company to initiate a dividend in 2011.
Getting in the game
More technology and biotech companies have embraced dividends
Source: FactSet. As of June 30, 2017.
Look beyond U.S. borders
Another way to expand possibilities for income is by adopting a global perspective. Today, companies and industries are increasingly global in terms of their markets, revenue, competitors and means of production. Likewise, the investment universe for blue chip, high-dividend equities is global.
The current dividend yields of major equity indexes in Canada, Australia, the U.K., Singapore and Germany compared favorably with the yield in the U.S. as of August 31, 2017.
Of course, not all dividend opportunities are equal. Look for companies with attractive competitive positions in their markets that have the ability to sustain dividends. And with the Fed raising rates in the U.S., dividend payers domiciled in other markets where rates are likely to remain low may be more attractive.
Look to overseas markets for dividend payers and growers as dividend yields can often exceed those in the U.S.
Source: FactSet, Capital Group. Yields calculated based on MSCI country indexes. Data as of August 31, 2017.
Be selective within higher yielding sectors
Although valuations are a consideration, there may continue to be attractive opportunities in higher yielding sectors. However, an investor has to be selective. For example, there are some structural advantages right now in the U.S. telecommunications industry.
AT&T and Verizon, the two major players with the strongest networks, have evolved from traditional phone companies to more diversified businesses. As the two dominant cell phone providers, the companies have learned to play nice with each other, so to speak. They have also benefited from the fact that consumers have less of an incentive to switch cell phone providers. The cost advantage of doing so is not as great, since companies are essentially no longer subsidizing new handsets. In addition, many people are delaying handset purchases because they are satisfied with their current ones. Although these companies have not grown much, they can be a reliable source of dividends.
When looking at higher yielding sectors, consider investing in high-quality stocks meeting strong valuation and financial metrics criteria. For example, has the dividend-paying company fully earned its dividend over the last five years — meaning, did the firm’s earnings per share exceed its dividend per share? The answer matters. Companies that don’t earn their dividend generally are either having to borrow to pay it or make other financial moves to get there. Either scenario could cause negative side-effects for investors.
A track record of consistently paying dividends in most years is also important for many investors. Screening for such financial and valuation metrics serves two purposes. One, doing so gives one greater confidence in the firm’s capacity and willingness to pay dividends. Second, shares of companies with strong business models, healthy balance sheets and a long-standing commitment to a dividend may hold up better in volatile markets, potentially providing a measure of downside resilience.
Capital’s multi-asset approach to income
One example of how Capital Group seeks to meet income needs for investors using a multi-asset strategy is expressed in Capital Income Builder®, a fund that aims to provide a relatively high level of current income and growth of income. The fund pursues these objectives by investing in a mix of bonds and companies across the dividend-paying spectrum. The fund invests heavily in traditionally high-yielding sectors, such as utilities and consumer staples, but it also targets lower yielding companies with the potential to meaningfully grow dividends over time.
Investors with income needs have been well served by this approach. A hypothetical $500,000 initial investment in Capital Income Builder, which assumed a $25,000 withdrawal the first year that was increased 3% each year to account for inflation, produced a total of $1,097,106 in withdrawals and had an ending value of $2.69 million over the fund’s 28-year lifetime (see chart below). This ending value was more than five times the original investment, $504,087 more than the S&P 500 Index and $1.08 million more than a blended index (comprising 60% stocks and 40% bonds).
While past results are not predictive of results in the future, Capital Income Builder has consistently provided income to help meet investors’ needs, despite the midpoint in its history when tech stocks ruled and dividend-paying companies had fallen out of favor.
Over its lifetime, the fund has not only held fast to its objective of producing income but also achieved its results with less volatility (as measured by standard deviation) than both the index and index blend.
A unique contour of results
Capital income builder’s history of delivering income
For standardized results net of fees, refer to the composite investment results table within this communication.
Investment results (%) (As of 9/30/2017)
|Fund||1 Year||5 Years||10 Years||Lifetime (Fund Inception 07/30/1987)||Expense Ratio||Annualized 30-Day SEC Yield|
|Capital Income Builder (F-2)||10.31%||7.71%||4.21%||9.52%||0.40%||3.23%|
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The SEC yield reflects the rate at which the fund is earning income on its current portfolio of securities while the distribution rate reflects the fund's past dividends paid to shareholders. Accordingly, the fund's SEC yield and distribution rate may differ.
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