Why US Tax Reform Could Drive Dividends Higher

In the first few months of 2018, some US companies and multinationals have raised their dividends by 10% or more—a higher percentage increase than we’ve seen in a few years. Don Taylor, portfolio manager for Franklin Rising Dividends Fund and chief investment officer, Rising Dividends Strategies, Franklin Equity Group, explains why he thinks that trend is likely to continue as more companies make plans for extra cash due to US tax reform. He also shares his views on sectors he thinks have the potential for long-term dividend growth.

While the merits of the Tax Cuts and Jobs Act of 2017 enacted last December may be debatable, we see one clear benefit: many US companies will see an increase in after-tax cash flows. Many market observers are waiting to see what those companies plan to do with the extra cash in their coffers.

Dividends, often drawn from earnings, are one way in which companies may choose to reward investors. They are typically cash payments made on a regular basis, such as quarterly or annually.

Our research suggests companies that grow their dividends tend to experience greater long-term stock price appreciation than companies that maintain their dividends or don’t pay one at all. And we have found that a consistently rising dividend tends to be an indicator of solid earnings growth, a resilient business model and a commitment by management to return cash to shareholders.

Tracking Dividend Increases

We define the “dividend season” as essentially a six-month period often starting in November and running through April. We have found that a number of companies tend to increase their dividend right before, or right after calendar year-end. Then, another group will do so around the time of their annual meetings.

Based on our analysis, the weighted average dividend increase for the underlying holdings of the Franklin Rising Dividends Fund’s portfolio troughed at 8% at one point in 2017. However, in the first two months of 2018, we’ve seen some companies raise their dividends by 10% or more—a higher percentage increase than we’ve seen in the past several years. As of February 26, 2018, the weighted average year-over-year dividend increase of the holdings in the portfolio is now 9.25%—and we think this metric is likely to improve as we move through the course of this year.

In February, UPS, a US-based delivery company that primarily delivers packages in the United States, increased its dividend by nearly 10%.1 In our view, that increase wouldn’t have been as large without a reduction in the US corporate tax rate from 35% to 21%.

We’ve also seen multinationals—such as Air Products & Chemicals, Aflac and Pepsi—raise their dividends by double digits this year.2 Those increases are larger than in past years and, in our view, are most likely due to a combination of the lower US corporate rate and incentives to bring home overseas cash. As part of recent US tax reform, foreign earnings can be repatriated to the United States at a tax rate of about 10% through 2025, instead of the previous standard 35% corporate rate.