While equity markets continue to struggle, an increasing number of financial advisers are finding value in dividend-yielding stocks.
In fact, equity income investing has become one of the best plays in the market, with quoted companies paying out a record $1 trillion in dividends last year, according to the Henderson Global Dividend Index.
And relative to other asset classes, dividend-paying stocks are likely to outperform, especially outside the U.S., where the practice of returning earnings to shareholders is more common.
So with about 70% of the world's dividends coming from non-U.S. companies, why do most advisers limit their equity income strategies to U.S. stocks?
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Global dividend-yielding stocks are attractively valued right now and yield more, on average, than their U.S. counterparts. Additionally, dividend yields are in most cases higher than corporate bond returns, with the added benefit that many dividends are poised for growth.
And by investing globally, investors can gain exposure to a broader range of income opportunities.
U.S. and European companies have long recognized the benefit of strong and growing equity income, attracting investors with the cash flow to sustain dividends and highlight a company's underlying health.
The dividend culture is spreading to the Asia-Pacific region and selected emerging markets. And with an increasing number of global corporate management teams focused on strengthening balance sheets and generating good cash flow, the case for long-term dividend growth is strong.
This broadening universe provides an attractive diversification opportunity, especially as the combination of reinvested income and capital growth has led to long-term outperformance of higher-dividend-paying stocks over the wider equity market.
Yet some dividend strategies have become overly reliant on a low number of high-yielding stocks that dominate the market in a particular country. A global perspective, on the other hand, provides country diversification and optimizes opportunities at a sector level.
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High-yielding equities, however, can be more risky than their lower-yielding counterparts, particularly after periods of strong market performance where stock price gains push yields down.
Remaining high-yielding stocks often are structurally challenged businesses or companies with high payout ratios that may not be sustainable. An investor simply focusing on yields or gaining exposure through a passive product such as a high-yield index tracker fund may end up owning a disproportionate portion of these companies, often known as “value traps.” It also is worth noting that companies that cut dividends tend to suffer poor capital performance. It is essential to analyze the sustainability of a company's ability to pay income.
A global approach also offers equity investors the opportunity to receive income from different sources throughout the year. For example, European companies typically pay out more than three-fifths of their annual distribution during the second quarter. North America shows the least seasonality with many firms making quarterly payments. U.K. firms tend to spread payments more smoothly than in other parts of the world, although they tend to pay larger final dividends in the spring and summer following annual general meetings. There also has been a steady flow of global stocks returning cash via special dividends and share buybacks, further supporting the case for international diversification.
Encouraged by the general health of companies worldwide and disciplined management teams focused on improving cash flow, financial advisers with a global equity income strategy will be well-positioned for long-term growth.
Ben Lofthouse is a member of the global equity income team at Henderson Global Investors.