- Investors typically hold defensive stocks for dividend income, lower volatility, and resiliency during economic uncertainty
- Among dividend payers, the strongest performance has been historically delivered by companies that consistently grow their dividends
- Dividend growers can be found across the economy, but their number can fluctuate significantly with market performance. We believe bottom-up, fundamental analysis is crucial to identify these companies
Defensive stocks that pay dividends have long been sought out by investors, especially during periods of market uncertainty. These companies tend to generate more predictable earnings and cash flows, which can make their stocks less volatile, less exposed to sell-offs, and more recession resistant. Dividend-paying stocks, however, exhibit a range of performance characteristics. Companies that grow their dividends have historically been lead performers, including when compared to other companies that simply maintain dividends. In addition, dividend growers have demonstrated lower volatility of returns compared to steady-but-flat dividend payers, non-dividend payers, and dividend cutters (Exhibit 1).1
Dividend payers have traditionally been found in the materials, utilities, and consumer staples sectors, as companies in these spaces generally provide goods and services with relatively inelastic demand. While this remains largely true, the economy has evolved and dividend payers can now be found in some new areas. Today, companies in a range of industries—including technology, luxury, and healthcare—have matured into large or mega cap firms that have maintained their competitive position through continued innovation and expansion into new markets or by leveraging an established business that cannot be easily replicated by competitors. For example, more than half of all US large cap technology companies pay dividends—just a little below the total for healthcare (Exhibit 2). Investors seeking dividend growers should consider all sectors of the economy.
We believe fundamental analysis plays a critical role in identifying dividend growers by focusing on the dynamics of leverage, valuation, management quality, and growth prospects at the company level. For example, a fundamental investor may find that a company that pays out a relatively high dividend may starve itself of reinvestment and thus undermine its long-term prospects. Other companies may be unable to sustain their dividend payments due to competitive pressures or a deteriorating macroeconomic outlook. And some companies will use debt to fund dividends in a bid to attract market support. In our experience, high quality dividend-growing companies have signs of financial health: strong business fundamentals, increasing free cash flow, and shareholder-friendly management teams.
This analysis is crucial in our view because some dividend-paying companies may fail to provide defensive characteristics when they are needed most. The overall number of dividend paying stocks has fluctuated over the past 25 years, often reflecting contemporary economic conditions. Companies distributed dividends when growth was strong, sentiment was favorable, and consumers were optimistic. The number of dividend payers, however, decreased during the global financial crisis and when the global economy shut down due to COVID-19. As the economy gradually recovered from these downturns, so did the number of dividend payers.
We find it notable that the number of dividend growers can vary significantly depending on the market environment. During the dotcom bust and global financial crisis, the number of dividend growers fell by nearly half, while the number of companies cutting or holding their dividends steady rose sharply (Exhibit 3). This illustrates the importance of skilled active management to identify the high quality dividend-growing companies that can hold up better when market volatility rises.
Companies that can maintain and grow their dividends during challenging times can be a critical allocation for investors. These companies may be able to contribute to defensive characteristics in an overall portfolio, including some inflation protection and outperformance in down markets:
- Companies with consistent cash flows and strong pricing power tend to be better positioned than competitors to maintain margins in the face of rising costs and interest rates. Due to their relative stability, absolute returns of defensive, dividend-paying companies have performed better than the S&P 500 Index during high inflation periods as well as the previous six rate hike periods since the 1980s.2
- Defensive equities also tend to be more resilient in downturns. As such, those stocks that grow dividends have historically outperformed when markets are falling.3
Finding consistent dividend payers, and especially dividend growers, over the long term is always difficult but worthwhile, in our view. In today’s uncertain markets, we believe investors are most likely to identify these companies by considering all economic sectors and relying on skilled, fundamental analysis.
The views expressed herein are those of Jennison investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice and should not be considered investment advice.
Certain third party information in this document has been obtained from sources that Jennison believes to be reliable as of the date presented; however, Jennison cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. Jennison has no obligation to update any or all such third party information. There is no assurance that any forecasts, targets, or estimates will be attained.
1Ned Davis Research
Dividend Paying vs. Non-Paying:
Each stock's dividend policy is determined by its indicated annual dividend. We classify a stock as a dividend-paying stock if the company indicates that it is going to be paying a dividend within the year. This is determined programmatically using indicated annual dividend data. A stock is classified as a non-payer if the stock's indicated annual dividend is zero. The indicated annual dividends are updated on a daily basis, so the most up-to-date information is used.
The index returns are calculated using monthly equal-weighted geometric averages of the total returns of all dividend-paying (or non-paying) stocks. A stock's return is only included during the period it is a component of the S&P 500 index. The dividend figure used to categorize the stock is the company's indicated annual dividend, which may be different from the actual dividends paid in a particular month.
Dividend Growing, No-Change-in-Dividend, and Dividend Cutting
Each dividend-paying stock is further classified into one of the three categories based on changes to their dividend policy over the previous 12 months. Dividend Growers and Initiators include stocks that increased their dividend anytime in the last 12 months. Once an increase occurs, it remains classified as a grower for 12 months or until another change in dividend policy. No-Change stocks are those that maintained their existing indicated annual dividend for the last 12 months (i.e., companies that have a static, non-zero dividend). Dividend Cutters and Eliminators are companies that have lowered or eliminated their dividend anytime in the last 12 months. Once a decrease occurs, it remains classified as a cutter for 12 months or until another change in dividend policy.
2Ned Davis Research. January 1, 1973–December 31, 2022. High inflation is defined as CPI-U greater than 4%. Average return during high inflation periods is based on the equal-weighted geometric average of dividend-paying and non-dividend-paying historical S&P 500 stocks, rebalanced monthly.
3Ned Davis Research. January 1, 1973–December 31, 2022. Defensive / dividend payer performance is based on the equal-weighted geometric average of dividend-paying historical S&P 500 stocks, rebalanced monthly. Performance is compared to Large Cap equities (S&P 500 Index); Value equities (Russell 1000 Value Index); Growth equities (Russell 1000 Growth Index); and Utilities (Utilities sector of the S&P 500 Index).