Are dividend-paying stocks better in a rising interest rate scenario?

Dividend-paying companies may continue to reward investors looking for some defense should the economy continue to slow.

Are dividend-paying stocks better in a rising interest rate scenario?
S&P 500 High Dividend Index and MSCI Europe High Dividend Index have delivered positive total returns for the year.

If the yield from the 10-year Treasury bond is more than the dividend yield of stocks, the attractiveness of the former increases. From the level of 1.7 per cent last seen in January 2022, the US 10-year yield had shot up above 3.20 per cent and is currently around 2.89 per cent. After the recent jobs data, the Fed is expected to continue raising rates to cool inflation down, which may keep the yield higher. The question remains – Are dividend-paying stocks preferred in a rising interest rate scenario?

Jeffrey Kleintop, Managing Director, Chief Global Investment Strategist Charles Schwab & Co., Inc. in a recent note writes, “ As the yield on the 10-year Treasury bond climbed above the dividend yield for most stocks early this year, many investors wrote off the idea of focusing on stocks’ yields. But dividend payers have deserved attention this year and may continue to reward investors looking for some defense should the economy continue to slow.”

The stock prices of dividend-paying stocks have shown an uptrend in recent times. High-dividend-paying stocks have been outpacing the overall stock market this year in the U.S., Europe, and Japan, except during July. By holding high-dividend stocks in a portfolio, you get the best of both the world – potential for appreciation and regular income.

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Both the S&P 500 High Dividend Index and MSCI Europe High Dividend Index have delivered positive total returns for the year through the end of July, while the S&P 500 is down 13% and MSCI Europe Index is down 7% (as measured in euros). In Japan, the MSCI Japan High Dividend Index is up 13% this year compared with losses for the MSCI Japan Index (as measured in yen).

“History shows us the benefits of a focus on high-dividend payers during recessionary bear markets. In every recessionary bear market of the past 50 years high-dividend-paying stocks have outperformed the overall market, except for the Global Financial Crisis in 2008-09, when financials were forced to eliminate their dividends,” adds Kleintop.

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High dividend-paying stocks tend to show lower volatility in prices and in times of rising prices work out to be a good bet against inflation. Companies in the Utilities and Consumer Staples sectors tend to pay much higher dividends than companies in other sectors. Kleintop informs that the four most popular ratios for measuring a company’s ability to pay its dividend are – A high dividend payout ratio, low dividend-coverage ratio, low free-cash-flow-to-equity, and high net-debt-to-EBITDA.

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