The Value of Dividends in Any Season

Value stocks have fared better than growth stocks this past year, benefiting from a more uneven economic outlook, rapidly rising interest rates and red-hot inflationary pressures.1 But with the economic and market outlook murkier than at the start of 2022 and earnings for many companies coming under pressure, we believe dividends should be an additional consideration in generating a substantial total return over time.

Strong signals

Dividends offer an important signal. Companies that pay consistent dividends often generate durable free cash flow. Furthermore, the dividend is usually less subject to the whims of management, and the markets, than a stock buyback. Companies can cancel or reduce their stock repurchases depending on where their shares are trading, while companies try to pay out dividends independent of stock price movements.

When examining a dividend paying stock, investors can focus on a few things, including how high the yield is or how consistently the company raises its dividend each year. A higher dividend yield does not always correspond to dividend stability, or consistency in raising it.

Those companies that provide a steady or rising dividend may have gradually increasing earnings and cash flow that is not always present in the highest-yielding stocks. And dividend raisers historically have seen their stock prices outperform those that have cut their dividend or do not pay one at all. Companies that have the highest yields have often seen their stock price fall sharply, which may indicate added stresses worth considering through deep bottom-up, fundamental analysis.

Just a cut

Getting the right dividend policy is vital for long-term value creation, in our view. As value investors, we prefer stable or growing dividends backed up by robust free cash flow generation, but we do not necessarily view dividend cuts negatively, particularly if it indicates that the company is using the cash it conserves in an appropriate way to reposition its business and reinvigorate growth.