Deep Dive: Dividend stocks, hot this year, may get even hotter thanks to the Federal Reserve

Dividend stocks, which have performed well this year, may get another boost if the Federal Reserve cuts interest rates.

With lower rates, income-seeking investors could use dividend stocks more than ever, and growth investors may also be interested because declining low interest rates prop up prices of higher-yielding stocks.

The S&P 500 Index SPX, +0.97%  has risen 15.3% this year, driven in part by the change in Federal Reserve policy in March — there’s high confidence the policy-setting Federal Open Market Committee will begin to lower interest rates as early as Wednesday.

Investors have already anticipated rate cuts by pushing yields on U.S. Treasury paper lower across the board, and we now have an inverse yield curve, with yields on three- and TMUBMUSD03M, -0.36%  six-month Treasury bills TMUBMUSD06M, -0.24%  higher than the yield on 10-year notes TMUBMUSD10Y, +0.54%

The Federal Open Market Committee’s policy statement will be released at 2 p.m. June 19. Read about the Fed here:

• Mark Hulbert: How to make money from the Fed’s meeting this week

• History suggests Fed can’t make ‘insurance cuts’ to keep expansion alive

• A surprise interest-rate cut by the Federal Reserve could be its best decision: Caroline Baum

• Opinion: Stock market will be sorely disappointed by a Fed rate cut

The inverse yield curve has traditionally been considered an indicator of a coming recession. Then again, Mark Grant, the chief global strategist for fixed income at B. Riley, said in his “Out of the Box” email on June 12 that he believed the rate inversion reflects “merely that the Fed, to date, has not bought Treasury bills and so the 800-pound gorilla has not yet entered that room. I expect them in shortly, however.”

European Central Bank President Mario Draghi added fuel to the fire Tuesday, saying eurozone economic indicators were “tilted to the downside” and that “additional stimulus will be required” if the numbers don’t improve.

Anticipation of renewed stimulus by the Fed has led to good performance among three of the four stock sectors of the S&P 500 with weighted aggregate dividend yields above 2.5%. Here are the 11 sectors sorted by dividend yield, showing their weighed aggregate price changes this year and last year:

Leaving aside the energy sector, which is tied to the vagaries of oil and natural gas prices, the utilities, real-estate and consumer-staples sectors have performed well this year, especially when considering that most of the companies in those sectors aren’t considered dynamic, rapidly growing innovators.

It is remarkable to see a 22% increase for the real-estate sector in 2019, excluding dividends, even after it outperformed, slightly, the full S&P 500 in 2018.

Dividend-stock lists

The best way to invest in dividend stocks may be to focus on increases of payouts, hich we discussed in detail here, rather than higher yields. Below are lists of higher-yielding stocks, subject to certain criteria.

If you are considering common stocks with high current dividend yields, it is very important that you have confidence in a company’s ability to maintain and increase its dividend. You should also do your own homework and look at the history of dividend payments. Has the dividend been cut over recent years? When? Why? That and your own careful consideration of the company’s ability to compete over the next 10 years are critical things to consider.

One way to estimate a company’s ability to maintain or raise its dividend is to compare its free cash flow yield to its dividend yield. Free cash flow is remaining cash flow after planned capital expenditures. This is money that can be used to raise dividend payments, repurchase shares, make acquisitions, expand organically or for other corporate purposes. If the free cash flow yield is lower than the dividend yield, it isn’t a very good sign. If it is not a temporary phenomenon, the company may have to lower the dividend.

For real-estate investment trusts, funds from operations (FFO), a non-GAAP figure, is used in the industry to gauge dividend-paying ability. FFO adds depreciation and amortization back to earnings, while subtracting gains on the sale of real estate. So REITs are listed separately below.

Non-REIT dividend stocks

Looking at free cash flow for the past four reported quarters, there are 53 non-REIT S&P 500 stocks with dividend yields of 3.5% or higher that have “headroom” to cover higher dividend payouts.

Here are the 10 with the highest dividend yields that also haven’t cut their regular dividend payments over the past five years (20 quarters), according to data provided by FactSet:

You can click on the tickers for more about each company, including stock performance charts and news coverage.

Many of these companies are weathering storms, including Macy’s M, +0.83% which is competing with Amazon.com AMZN, +0.81% and other online retailers, and AT&T T, +0.43% which is going through a brutal period of declines in subscribers for its pay-TV services, to name two examples. So it is not surprising to see that only two of these companies are favored by a majority of sell-side analysts:

Here are the 10 stocks of this group of 53 with the highest percentages of “buy” or equivalent ratings by analysts polled by FactSet, once again screened to exclude any companies that have cut regular dividends over the past five years:

REITs

There are 31 real-estate investment trusts in the S&P 500. Here are the eight with the dividend yields of at least 3.5% that have “headroom” based on funds from operations (FFO) over the past 12 reported months and also haven’t cut dividends for the past five years:

Here’s a summary of analysts’ opinions of these eight REITs:

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