The Benefits of Dividend Investing
Fiscal 2020 turned out to be a challenging year for dividend investors as the coronavirus pandemic has forced hundreds of companies to slash dividends.
Although dividend aristocrats have sustained their growth history with small increases, the S&P 500 Dividend Aristocrats Index is up only 6% so far in fiscal 2020 compared to a more than 14% surge of the broader S&P 500 Index.
One of the main reasons behind the broader index outperformance is tech stocks that have performed well during the pandemic. FAANG stocks plus Microsoft are among the biggest gainers; the group currently accounts for almost 25.8% of the total S&P 500 market capitalization.
ℹ️ The S&P 500 Dividend Aristocrats Index is composed of 65 companies that have raised dividends every year in the past 25 years.
What’s interesting, dividend aristocrats have outperformed the broader market index in the past ten years, with a return of 16% through the end of 2019.
Dividend investing has been gaining investors traction this year as pandemic has forced governments to cut interest rates to near-zero range.
Dividend investing is considered one of the safest investment options. This is because dividend-paying companies are generally more stable than other companies as these companies also perform well during the volatile economic environment.
Consequently, adding dividend stocks could also help in diversifying the stock portfolio and lowering the threat of uncertainty.
The Change in Strategy
A lot of people still believe investing in dividend stocks means buying stocks of mature companies that have the potential to generate sustainable growth in free cash flows.
The thesis is turning false as technology and internet stocks are now offering robust growth along with a double-digit dividend increase. These high growth companies have outperformed throughout fiscal 2020, with expectations that tech and online spending will increase at a substantial rate in fiscal 2021.
Stock market gurus like Warren Buffet, who is an ideal investor and stock picker for conservative investors, have also changed his investment style in the past couple of years. He is now looking more towards high growth companies that offer cash returns for investors. Apple (NASDAQ: AAPL) comprised almost half of the Berkshires Hatheway portfolio at the end of the September quarter.
Let’s talk a bit more about why investors need to look beyond dividend aristocrats.
It is true that investing in dividend aristocrats is one of the safest ways to play with stock markets, but it’s not the best way to generate the highest possible returns in the current environment. For instance, Coca-Cola (NYSE: KO) has lifted its dividend in the past 58 consecutive years, making it a Dividend King of the S&P 500.
While Coca-Cola has been sustaining its dividend growth history, the average dividend growth rate is not impressive. Its average dividend growth rate stood around 5% in the past five years, with expectations that the dividend growth rate will stand around 3% in the years ahead. The latest dividend increase came in at 2.5%.
AT&T (NYSE: T) and Verizon (NYSE: V) is another example of companies that are raising dividends at a slow pace. Several other companies in the 65 member list are struggling to make hefty raises either because of the pandemic, economic instability or changing market trends.
Past performance has never been considered as a guarantee for a successful future. Therefore, investors are suggested to follow the changing market trends.
Internet and tech stocks are likely to boom in the days ahead when compared to dividend aristocrats like Exxon (NYSE: XOM) that are struggling to generate enough cash for dividends.
Instead of glorifying the dividend stability potential of dividend aristocrats, we have decided to point out the best dividends stocks to buy in 2021 that are likely to outperform old fashioned business models.
ℹ️ The stock selection process is entirely based on future fundamentals and market trends.
Best Dividend Stocks to Buy in 2021 – Top 5 Picks
Microsoft Corporation (NASDAQ: MSFT)
Market Cap: $1.62 trillion
The third-largest US public company Microsoft Inc. (NASDAQ: MSFT) has been rewarding investors with hefty cash returns along with significant share price appreciation.
Microsoft’s strategy of moving the business model towards cloud markets has enhanced its future fundamentals.
The company has raised dividends in the past 17 straight years, with an average dividend growth rate of above 10% in the past five years. The latest dividend increase stood at 9.8%. In addition to dividends, the shares of the software company grew 43% in the past twelve months.
Its dividend growth is safe amid a rosy outlook and low payout ratio. Its dividend payout ratio based on income stands around 33%, meaning the software company is distributing only 33% of profit to shareholders.
On the other hand, Microsoft has been expanding profits at a double-digit rate. Its net income of $13.9 billion in the September quarter increased 30% from the past year period while diluted earnings grew 32%.
The company says digital transformation will play a big role in business performance in the next decade.
“The next decade of economic performance for every business will be defined by the speed of their digital transformation,” said Satya Nadella, the chief executive officer of Microsoft. “We are innovating across our full modern tech stack to help our customers in every industry improve time to value, increase agility, and reduce costs.”
Microsoft has aggressively been expanding its cloud-based product offerings. Its cloud revenue came in at $15.2 billion in the September quarter, up 31% year over year.
Broadcom Inc. (NASDAQ: AVGO)
Market Cap: $166 billion
With the average dividend growth of 55% in the past five years, Broadcom (NASDAQ: AVGO) appears like the best dividend stock to buy in 2021. The chipmaker is likely to benefit from the changing market trends. In addition, its strong cash generation potential backs its dividend growth projections.
Broadcom has raised dividends in the past nine consecutive years. It currently offers a quarterly dividend of $3.25 per share, yielding around 3.16%. Moreover, its share price grew 30% so far in fiscal 2020.
The chipmaker appears in a strong position to extend its shareholder’s returns. The company expects its December quarter revenue in the range of $6.25-$6.55 billion and EBITDA around $3.74 billion.
“Our outlook for the fourth quarter reflects a strong anticipated ramp in wireless, as well as the continuing surge in demand for networking from cloud and telecom customers, more than offsetting expected softness in the enterprise,” said Hock Tan, President, and CEO.
Its strong cash generation potential is also supporting dividends. Broadcom has generated $3 billion in free cash flows in the latest quarter compared to dividend payments of only $1.3 billion.
Skyworks Solutions, Inc. (NASDAQ: SKWY)
Market Cap: $24 billion
Skyworks Solutions (NASDAQ: SKWY) is expecting double-digit growth in revenue and earnings both sequentially and year over year basis amid the introduction of 5G-enabled smartphones and infrastructure.
It offers a quarterly dividend of $0.50 per share. The dividend growth rate in the past five years stood around 15%, thanks to sustainable growth in financial numbers.
Its September quarter revenue of $950 million grew 30% sequentially and 16% on a year-over-year basis, with expectations of similar gains in the December quarter,
“We expect double-digit sequential revenue and earnings growth in the December quarter, fueled by content gains and product ramps across multiple 5G-enabled smartphone platforms and increased demand across our broad markets portfolio,” said Kris Sennesael, senior vice president and chief financial officer of Skyworks.
On the other hand, its shares jumped 50% in the past twelve months. Despite the recent gains, the market pundits are seeing more share price appreciation in fiscal 2021. For instance, Needham has provided a price target of $200 with a buy rating while KeyBanc has set a $170 price target.
Target Corporation (NYSE: TGT)
Market Cap: $87 billion
The robust growth in digital sales has enhanced investors’ confidence in Target Corporation (NYSE: TGT). The shares of one of the largest US retailers soared 40% in the past twelve months due to pandemic related growth in demand.
In addition to share price gains, Target is one of the best dividend stocks to buy in 2021. The retailer has raised dividends in the past 52 years. It currently offers a quarterly dividend of $0.68 per share.
Its dividend growth is safe because of its rosy outlook. The digital presence has been adding to revenue growth trends.
Target has generated a 21% growth in consolidated revenues during the September quarter, thanks to a 155% year-over-year increase in digital sales. Online sales accounted for 10% of total comparable sales in the September quarter. Moreover, the reports suggest that digital grocery buyers in the U.S. are likely to jump from 131 million in 2020 to 147.4M in 2023.
Corning Incorporated (NYSE: GLW)
Market Cap: $29 billion
Shares of the material science company Corning (NYSE: GLW) grew 30% in fiscal 2020, but market fundamentals suggest more gains are ahead. It is also one of the best dividend stocks to buy in 2021 because of robust financial growth guidance. Its average dividend growth rate in the past five years stood at 13%.
Its future fundamentals are strong amid its exposure to multiple growth industries, including consumer electronics displays, smartphones, life science vessels, fiber optic networks, and automotive glass.
The company has generated 16% growth in September quarter sales compared to the previous quarter while the core operating margin grew 710 bps. The company says its December quarter revenue will increase in the range of 5-8% sequentially and operating margin growth will likely double the rate of sales growth.
FAQ about dividend stocks
What is dividend investing?
Investing in stocks for dividends is known as dividend investing. Dividend investing is one of the well-known ways for defensive investors to generate returns from volatile stock markets.
Is dividend investing different from value investing?
Yes, dividend investing is significantly different from value investing. Value investors like to buy stocks at discount without considering the dividend factor. The main aim of value investing is to generate returns from share price movements.
Does every company offer dividends?
Only stable companies with strong future fundamentals offer dividends to investors. Several big companies like Amazon (NASDAQ: AMZN) and Facebook (NASDAQ: FB) do not offer dividends. This is because these companies like to reinvest profits into the business.