Unloved Dividend Stocks Are Now Worth a Nibble

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The stampede into artificial intelligence, the market’s newest new thing, has left dividend stocks looking stodgy and unloved. They’re also becoming bargains.

The promise of AI and its ability to reduce costs and enhance products has investors dreaming of a new tech supercycle. Shares of ChatGPT investor

Microsoft

(ticker: MSFT) are up 31% in 2023, while

Nvidia

(NVDA) is up about 110% on hopes that AI will drive demand for its chips. It’s also a big reason that the tech-heavy Nasdaq 100 has gained 25% this year, leaving the rest of the stock market in its dust.

That includes dividend stocks, those companies with regular payouts that help to steady long-term returns. The iShares Select Dividend exchange-traded fund (DVY) is down almost 8% year to date, even though it yields about 4.7%. Even the

ProShares S&P 500 Dividend Aristocrats ETF

(NOBL), which contains stocks that have raised their payouts for 25 consecutive years or more, has gained just 0.1%.

Tech stocks fell apart just before the Federal Reserve started raising rates in early 2022, since rising rates hurt growth shares. Investors are now looking ahead to the expected end to the Fed’s interest-rate hiking cycle. As a result, stocks with no or low dividends—often tech and other growth stocks—are up 10% this year, according to Justin Walters, co-founder of Bespoke Investment Group, while stocks with the highest yields have dropped about 6%. That’s a 16 percentage point difference. The gap between the Nasdaq 100, which yields about 0.8%, and the iShares Select dividend is even larger, at a whopping 33 percentage points.

That’s too large a gap, and makes now a particularly attractive time for investors to pay attention to yield. The performance gap between the iShares Select Dividend and the Nasdaq 100 has widened the valuation gap, too. The median stock in the iShares ETF trades for about 12 times 2024 earnings, while the Nasdaq 100 trades for about 21 times. Eventually, the relative attractiveness of dividend stocks can be expected to draw new investors.

Yes, dividend payers might look even more attractive if they were to underperform by another 10 to 15 percentage points, which would make them the most attractive they have been relative to growth stocks at any point in the past five years. And yes, there are issues facing many high-yield dividend payers: Bank stocks have been hit hard by the regional bank turmoil, and energy companies have been dinged by lower oil prices. Short-term Treasuries, meanwhile, with their roughly 5% yields, could offer a safer alternative.

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But short-term government bond yields won’t look so attractive once the Fed’s rate-tightening ends. And there are plenty of dividend stocks to choose from that aren’t banks or energy companies.

Investors worried about the security of dividends in the

iShares Select Dividend ETF

can look to the ProShares S&P 500 Dividend Aristocrats instead. Though it yields just 2.5% and trades at 21 times 2024 earnings, it offers a level of quality over the highest-yielding stocks, which can be “cheap for a reason,” writes Chris Senyek, chief investment strategist at Wolfe Research. Dividend stocks could also benefit if the Fed doesn’t stop cutting interest rates—as some Fed governors suggested this week—and the economy continues to slow.

“During economic slowdowns or recessionary environments, our favorite yield-focused strategy is buying companies with a long track record of consistently increasing dividends,” Senyek writes. “This cohort of stocks has generally outperformed heading into and out of recessions.”

Also keep in mind that dividends have accounted for roughly 40% of stock returns over the past 100 years.

Dividends always matter—no matter what the next hot technology is.

Write to Al Root at [email protected]