Finding yield in dividendpaying

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1 Market & Investment Insights Finding yield in dividendpaying stocks Mike Holbert, Portfolio Manager, Active Equities Article Highlights: Low interest rates have spurred investors to search for yield outside of the bond market, including through dividend-paying stocks in the U.S. and abroad. Despite strong demand for dividend-paying stocks, investors can still get a comparable or even slightly better yield than they can from most U.S. Treasury-issued bonds. Now, with interest rates poised to rise, stocks may come under pressure though dividends have demonstrated over time and market cycles that they are an important contributor to total return. Investors with a long-term horizon should consider an approach that favors high-quality dividend payers as those companies tend to be less volatile through market peaks and valleys and when interest rates rise or fall. July 2, 2015 The low interest-rate environment of recent years may have been a big financial boon for consumers, helping to keep mortgage, credit card or car loan payments manageable. But for investors who rely on bonds, CDs or savings accounts to generate a steady of stream of income, low rates have been unwelcome. During this time, many investors have flocked to dividend-paying stocks in lieu of bonds or other traditional investments that generate yield. If carefully selected, dividend stocks have the potential to produce fairly reliable, predictable and recurring income important alternatives to the yield investors may have once gotten from traditional income-producing investments. While dividend-paying stocks also have downside risk, as do all stocks, numerous studies show that they have demonstrated less volatility and higher returns over time, not just compared to other investments that offer yield but also compared to stocks that don t pay dividends.

2 How have dividend stocks performed? Dividend stocks returned 9.3% over a four-decade period ended in 2014, compared with a 2.3% gain for stocks that didn t pay dividends. Over that same time, dividend stocks outperformed during bull markets and fell less during bear markets. 1 Historically, dividends have been a major contributor to the total return of stocks (see Exhibit 1). A $10,000 investment made at the beginning of 2000 would have grown to $14,587 by the end of March 2015 based on price change only. However, when adding the compounding effect of dividends, the same $10,000 investment would have almost doubled to $19,350. Exhibit 1 Demand for income along with a tremendous six-year run that saw the overall stock market nearly triple since its 2009 bottom has boosted valuations of dividend-paying stocks and therefore lowered their yields. However, dividend-paying stocks still remain appealing alternatives to traditional income-generating investments. The dividend yield of the S&P 500 hovered above 1.9 percent at the end of the first quarter of 2015, as shown in Exhibit 2, comparable to (or higher than) the payouts you d receive from most U.S Treasury bonds.

3 Exhibit 2 In fact, while the S&P 500 yielded about the same as the 10-year Treasury as a whole, 44% of dividend-paying stocks in the index actually yielded more than the benchmark U.S. government bond. In other countries, yield differentials favoring dividend stocks were even greater (see Exhibit 3). These included Japan, where 99% of stocks in the Nikkei 225 stock index yielded more than the 10-year Japanese Government Bond, and Germany and France, where 100% of the dividends of companies in the major equity market indexes outperformed their respective 10-year government bond yields. 2 Exhibit 3

4 While higher interest rates can offer a challenging environment for dividend investors, there are some factors that should mitigate an expected 2015 rise in rates. First, the Federal Reserve has been issuing strong signals for some time that it will tighten its policy and allow rates to rise, so investors will not be surprised. Second, there are many indications that such increases will be relatively slow and measured. Long-term rates aren t expected to rise significantly for years, which would potentially keep dividend-paying stocks attractive relative to fixed-income investments for some time to come. Which approach makes sense? Investors interested in dividend stocks should note that not all approaches to dividend stock investing are the same. Some funds focus on the highest-yielding stocks. This would seem to offer the greatest benefit, but a vast majority of stocks with double-digit yields are poised to cut their dividends. When this happens, stocks tend to underperform. Alternatively, a strategy focused on the stocks likely to raise their dividends can be problematic, because the growth rates of dividend hikes may have to be extremely high to match the appeal of other companies. For example, a company with a stock yielding 2% would have to increase its dividend substantially over several years in order to generate the same returns of a company whose stock pays a yield of 4%. The best strategy is one that offers a balance between high yield and dividend growth, focusing on high-quality dividend stocks. These tend to perform relatively well, especially during market downturns, because of their lower volatility. Highquality companies as measured by cash flow, debt and earnings potential are less prone to wide price swings in up and down markets. Investors also should be aware that some international stocks offer potentially attractive dividends, and that some countries historically favor dividends. Switzerland, for example, is known as a market where many companies pay dividends. Australian companies have a history of paying strong dividends. Conversely, companies in Japan that offer more than a 2% dividend yield are scarce. By including international dividend-yielding stocks in a portfolio, investors could improve diversification, which could offer protection and help both in rising and falling markets.

5 What should you consider before investing? Several factors can dim the appeal of dividend-paying stocks. In some environments, stock market investors prefer fast-growing companies over valueoriented companies, including those that pay dividends. Also, currency shifts can affect the value of dividends paid by international stocks. The U.S. dollar, for example, has been rising rapidly in recent months, hitting 12-year highs against both the euro and the Japanese yen, and record highs against some currencies in emerging markets. For U.S.-based investors, that dollar strength can erode some (if not all) of the value of dividends paid by foreign companies with declining currencies. As with all investments, it s important to understand both the risks and potential rewards of dividend stocks. For more information on adding income-generating potential to your portfolio, contact your TIAA-CREF advisor. This material is prepared by and represents the views of Mike Holbert, and does not necessarily represent the views of TIAA-CREF, its affiliates, or other TIAA-CREF Asset Management staff. These views are presented for informational purposes only and may change in response to changing economic and market conditions. This material should not be regarded as financial advice, or as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Past performance is not indicative of future results. Please note equity and fixed income investing involves risk. TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association (TIAA ). Teachers Advisors, Inc., is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). Past performance is no guarantee of future results Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY C24576