Dividend Prices Will Continue To Rise Even After COVID

| May 24, 2021

dividendAnnual dividend yields are falling against the backdrop of rising quotations, but the size of the payments themselves are growing.

For a significant part of investors, especially after the crisis, dividends are an excellent indicator of the stability and adequate valuation of a company.

The Annual Dividend Yield Of S&P 500 Stocks

In March 2021, the annual dividend yield of S&P 500 stocks reached a multi-year low of 1.45%. This is well below the multi-year average of 1.87%, especially March 2020’s record high of 2.31%. However, these figures aren’t all that they seem as the annual dividend yield is proportional to the size of the payments themselves, but inversely proportional to the share price. A year ago at the peak of the pandemic stocks were abnormally cheap, however, currently the market, on the contrary, is breaking record after record. This is why the annualized profitability has dropped significantly.

Therefore, a better indicator in this situation is not the annual dividend yield, but the average dividend per share. This figure is now $14.68, which is quite a lot. This has only risen above $15 at the end of 2019 and early 2020, whereas in 2017 it was consistently below $13, and in 2014 it did not rise above $10. With the average currently sitting close to the indicators of the relatively prosperous 3Q 2019, we see the potential for further growth.

The positive trend in dividend payments has been observed for several months. In the 4th quarter of 2020, 91 companies from the S&P 500 index increased dividends, and in the 1st quarter of 2021 – 120 companies. Thus, Oracle increased payments by 33%, T. Rowe Price – by 20%, BlackRock – by 14%. Dividends from chip maker Intel, energy company Xcel, telecommunications giant ComCast, and others grew slightly weaker, but also significantly.

It is important to note that most companies with medium and high dividends belong to the Value class – mature companies with an established market. For example, large-scale power engineering and, in general, classical industry. During the crisis, Value companies suffered more than “risky” companies of the Growth class (for example, Tesla), and even now they have not fully recovered from it. But this does not prevent them from raising dividends at an outstripping pace. What drives them?

When the economy recovers from the crisis, companies will have less room for outstripping dividend increases: they will no longer be able to rely on the rapid growth of profits as they did in the post-crisis recovery. If by that time the indices have already stopped growing or even partially sagged, then whether or not we’re in a ‘bubble’ situation will become less relevant.

The Factors That Motivate Raising Dividends

Why is it profitable for companies to raise dividends? Do dividends show the absence of a bubble?

One of the factors that motivate companies to raise dividends is the expectation of economic recovery and profit growth. By attracting investors today with “inflated” dividends, they expect that after the return of profits, these dividends will become the norm and may rise further. However, a lot is written about this factor, and we will not delve into it especially.

We will discuss the second factor in more detail: dividends are a signal that a company is not overvalued.

Now the market is overheated, and many are hearing giant P/E ratios (capitalization to annualized earnings) of some companies. For example, Tesla has it equal to 1089. This means that while maintaining the current profits and quotations, the investment will pay off for more than 1000 years, even if the company uses all the profits for dividends. In fact, Tesla has no dividends, and investors are counting primarily on the growth of profits and company quotes. The giant Amazon has a P/E of 81. This is much less than Tesla, but also quite high (likely payback of more than 80 years). At the same time, Amazon has no dividends either.

Intel’s Dividend Payments

However, not all companies are like that. The aforementioned Intel has P/E = 14. This is a very moderate value even for ordinary time, and even more so in the conditions of overvaluation of many companies. Intel now pays dividends with an annual yield of 2.1%, which is significantly higher than the average for the S&P 500. The investment company BlackRock has approximately the same dividend yield at P/E = 25, which can also be called a moderate amount.

It is easy to calculate: an overvalued company with a high P/E fundamentally cannot afford any noticeable dividends, except for a few “advertising” actions. For example, in order to consistently have a dividend yield of at least 2%, a company must have a P/E of no more than 50. Otherwise, dividends will not be secured by profits. This is impossible for Tesla and even Amazon, but it is easy for Intel: to provide such dividends, the company only needs to direct less than a third of its profits to them.

So, the amount of dividends, as well as the very fact of their payment, are closely related to the valuation of the company: dividends of 2-3% per annum and above – almost unambiguously indicate the high profitability of the company and the low valuation of shares. However, the opposite is not true: if the company does not have dividends, then this proves nothing. It can be both overestimated and moderately estimated. Many investors, wanting to avoid overvalued stocks, simply choose low P/E companies. But for those who want real guarantees of “ground under their feet,” dividends are a particularly important sign of no bubble.

Forecast About Dividends

Will higher dividends continue in the future?

When the economy recovers from the crisis, companies will have less room for outstripping dividend increases: they will no longer be able to rely on the rapid growth of profits as they did in the post-crisis recovery. If by that time the indices have already stopped growing or even partially sagged, then whether or not we’re in a ‘bubble’ situation will become less relevant.

However, we don’t see dividends declining. Over 10 years, the average dividend per share for the S&P 500 has grown 2.5 times, and this growth has been quite consistent, excluding the failure of 2020. It’s likely that in the coming months this figure will exceed $15 and begin to set new historical records.

Note: This article originally appeared at ValueWalk. The author is senior analyst, EXANTE, Victor Argonov.

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Category: Dividend Stocks

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The author of this article is a contributor to ValueWalk.com. ValueWalk is your everyday source of breaking and evergreen news on everything hedge funds and value investing.