Dividends are a significant part of the total return from stocks. But rather than evaluating stocks based on recent dividends, investors should ask: "How likely are my holdings to
raise their dividends?"
A recent research paper by Morningstar Inc. indicates that some of the biggest dividend payers may not be the most likely to raise dividends going forward.
The Standard & Poor's 500 stock index has gained an average 6.54% the past 20 years, assuming dividends were reinvested. Strip away dividends, and that return shrinks to 4.39% a year. (Those figures may seem low, but remember in May 2008, two major bear markets were lurking ahead.) In other words, dividends accounted for about a third of the S&P 500's total return.
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The largest dividend sectors by sheer dollars paid out are financial services and technology. This is due, in part, to the size of both sectors. Technology is the surprise here: Typically, investors think of tech stocks as paying no dividends at all. But 45 of the 70 tech companies in the S&P 500 pay dividends, and of those that do, the average dividend yield is 1.80%, according to S&P. Apple, which sits on enough cash to buy
Saturn, has a 1.37% dividend yield; Cisco pays 2.69%. (The S&P 500 has a 1.88% dividend yield.)
But technology might not be the place to look for consistent earnings growth. Tech stocks, which have seen the big
dividend increases over the past decade, are not exactly known for their consistency. Nor are health-care stocks, another big source of dividend income.
"Looking forward, it is worthwhile asking yourself whether technology and health care can continue to grow at rapid rates," writes Dan Kemp, chief investment officer for Morningstar's investment management team for the Europe, Middle East and Africa region. "One danger when casting such judgment is a recency bias. Of note, the past decade includes a major commodity slump that saw the likes of energy and materials struggle."
Mr. Kemp argues that it's best to look at a sector's overall likelihood of increasing dividends — as well as the effect of stock buybacks, which are another important source of investor return. (Valuation relative to earnings, of course, matters a great deal.)
In Morningstar's view, global telecommunications companies are most likely to have the highest annual total returns in the next decade, of around 5% in inflation-adjusted terms, followed by financials, which are still recovering from the losses — and dividend cuts — sparked by the financial crisis. Dead last: Consumer discretionary stocks, which Morningstar estimates will lose about 2% a year.
