Stock ETF investors may want to look outside traditional income-producing sectors such as utilities and REITs if they want companies that will be able to grow their dividends in the future.
Low bond yields have pushed income-starved investors into stocks. Yet the equity market’s higher-yielding sectors such as REITs, utilities and telecom failed to keep pace with the overall market during the recent rise in interest rates “as their payouts became comparatively less attractive,” says Dan Skelly, equity strategist at Morgan Stanley Wealth Management.
The good news is that dividends appear to be on solid footing even with the recent spike in Treasury yields. Companies have more cash on their balance sheets and over 80% of S&P 500 components are paying dividends, the highest level since 1999. [Dividend ETFs: The ‘Bondification’ of the Stock Market]
“However, we favor dividend-growth-oriented sectors and stocks over purely high yield equities,” Morgan Stanley said. “We note that stocks with modest dividend yields and the potential for higher dividends—as opposed to the highest-yielding stocks—have also produced solid relative returns over market cycles.”
Skelly thinks sectors with relatively high cash positions, higher revenue-growth potential and modest payout ratios are likely to produce the highest rates of dividend growth.
Specifically, he points to master limited partnerships. ETFs tracking this asset class include JP Morgan Alerian MLP Index ETN (NYSEArca: AMJ), Credit Suisse Cushing 30 MLP Index ETN (NYSEArca: MLPN) and Alerian MLP ETF (NYSEArca: AMLP). [MLP ETFs: High Yield and Low Volatility]
“We also like the health care and technology sectors, along with select consumer discretionary companies with higher-than-average exposure to the emerging markets,” Skelly said in a note.
Among State Street’s lineup of sector ETFs, investors can start their research with Health Care Select Sector SPDR (NYSEArca: XLV), Technology Select Sector SPDR (NYSEArca: XLK) and Consumer Discretionary Select Sector SPDR (NYSEArca: XLY). [Baby Boomers, Economy Drive Top-Performing Sectors]