An increasing number of companies are paying out more than they earned, potentially raising sustainability issues with high-yield-paying companies. Alternatively, investors can rest easier at night with exchange traded funds that specifically target quality companies with a history of dividend growth.
About 20% of S&P 500 companies that pay dividends have paid out more than they earned in the last fiscal year, or up 9% from a decade ago, reports Mark Fahey for CNBC.
To get a sense of sustainability of cash dispersals, ClientFirst Strategy president Mitch Goldberg points to a company’s dividend payout ratio, or the dividend per share divided by earnings per share – ratios above 1 indicate the company is paying out more than it’s earning, so lower numbers typically means a company has more wiggle room.
Over the past decade, all companies in the S&P 500 showed a rising dividend payout ratio, with a median ratio at a high of 37% today, compared to 20% in 2006.
High-dividend stocks may seem attractive in this extended low-rate environment, but these companies may be prioritizing short-term gains over long-term research and development. Goldberg warned that these companies may be at risk if a recession hits.
“It’s not going to take that much for these companies to acknowledge that they can’t keep up with their dividends,” Goldberg told CNBC. “I think investors who gorged on dividend stocks are in for a deeper pullback then they may have seen in previous cycles.”[related_stories]
Alternatively, investors have a number of high-quality dividend-paying stock ETFs to choose from. The Vanguard Dividend Appreciation ETF (NYSEArca: VIG) tracks U.S. stocks that have increased dividends on a regular basis for at least 10 consecutive years and has a 2.16% 12-month yield. The Schwab US Dividend Equity ETF (NYSEArca: SCHD) includes 100 stocks based on strong fundamentals, dividend yields and consistent dividend payouts for at least 10 consecutive years, and it has a 2.9% 12-month yield. The SPDR S&P Dividend ETF (NYSEArca: SDY) holds firms that have a minimum dividend increase streak of 20 years for inclusion and shows a 2.39% 12-month yield. The ProShares S&P 500 Aristocrats ETF (NYSEArca: NOBL) only includes companies that have increased their dividends for at least 25 consecutive years and offers a 1.89% 12-month yield.
Additionally, investors can also look to companies that reinvest their profits for future growth. The Elkhorn S&P 500 Capital Expenditures Portfolio (NasdaqGM: CAPX) targets companies that are diligently reinvesting in their businesses to increase market share and competitive moat. Specifically, CAPX takes the top 100 S&P 500 companies based on efficient capital expenditure as a way to track U.S. firms that have reinvested their money toward meaningful growth and innovation.
“The problem I have with financial engineering is that it’s a sugar high that wears off way too quickly, and it doesn’t in my opinion often leave companies better off over the long term,” Goldberg added. “Companies that didn’t reinvest over the last 10 years are going to pay the price.”
For more information on dividend stocks, visit our dividend ETFs category.