Published by Bob Ciura on March 24th, 2017
When uncertainty hovers over the economy, stocks tend to go down. After all, as the saying goes, the market hates uncertainty.
For obvious reasons, investors instinctively look at falling stock markets negatively.
However, while it may sound backwards, dividend investors should actually welcome uncertainty.
That’s because falling share prices make for better buying opportunities, especially when it comes with the strongest business models.
A great place to find many of these businesses is the list of Dividend Aristocrats, a group of companies in the S&P 500 that have raised dividends for 25+ years.
In addition to better buying opportunities, there are other reasons to start viewing uncertainty as a positive for long-term dividend investors.
This article will discuss a number of other reasons why uncertainty helps dividend investors.
Why Dividend Growth Investors Shouldn’t Fear the Unknown
It can be difficult to stay with stocks when the market is plunging.
One of the best ways to avoid the temptation to sell, is to build a portfolio that is prepared for whatever the future holds.
By doing so, investors can effectively tune out moments of uncertainty.
A well-rounded dividend growth portfolio should naturally include many of the blue-chip U.S. stocks that lead their respective industries, such as those that populate the Dividend Aristocrats list.
If that were the case, investors could at least know their dividends will still come in, even when stock prices are going down.
The Dividend Aristocrats all continued to raise their dividends, even during the 2008-2009 Great Recession.
For example, from Aug. 1, 2008 to Feb. 1, 2009, Johnson & Johnson (JNJ) stock fell from $70 per share to $50 per share.
The U.S. economy was facing a great deal of uncertainty, and was mired in arguably the worst recession since the Great Depression.
However, the company continued to grow earnings-per-share and dividends during this period. The company’s earnings-per-share during the Great Recession are shown below:
- 2007 earnings-per-share of $4.15
- 2008 earnings-per-share of $4.57 (10% increase)
- 2009 earnings-per-share of $4.63 (1% increase)
- 2010 earnings-per-share of $4.76 (3% increase)
J&J grew earnings-per-share each year, throughout the recession.
This was due in large part to its strong brand, and pristine balance sheet: J&J is one of only two U.S. companies that earns the coveted ‘AAA’ credit rating from Standard & Poor’s.
J&J’s consistent earnings growth allowed it to continue raising its dividend. In fact, it has increased its dividend for 54 consecutive years.
In addition to being a Dividend Aristocrat, J&J is also one of just 19 Dividend Kings, a group of companies with 50+ years of dividend growth.
J&J, along with the rest of the Dividend Aristocrats, saw their share prices decline significantly during the Great Recession.
The benefit, then, of these stock market declines is that they are a welcome buying opportunity. Investors were given the chance to re-invest dividends, or add to a position, all at lower prices.
Preparing one’s portfolio by focusing on the best businesses, and diversifying across industries, investors are acknowledging that nobody can predict the future.
In investing, humility is a virtue. Uncertainty always exists, and there is no way to predict exactly what will happen in the future, and how the markets will react.
By accepting this, investors can create more effective portfolios, centered around strong dividend stocks.
Examples of Uncertainty Creating Opportunities Today
The lessons of the Great Recession can be applied, whenever uncertainty rears its ugly head.
For example, heading into 2016, the financial sector was shrouded in uncertainty. There was considerable doubt as to whether the Federal Reserve would finally raise rates (which it did in December).
Once the uncertainties of the November election and the direction of interest rates abated, valuations expanded considerably across the financial sector.
Bank stocks like Wells Fargo (WFC) and JP Morgan Chase (JPM) have been among the biggest winners since November 8.
While there remain several good reasons to consider buying Wells Fargo and JP Morgan Chase, as they are still reasonably cheap with solid dividend yields, they aren’t as cheap as they were last year.
A good example of uncertainty creating opportunity today, could be the challenges facing the U.S. auto industry.
Auto makers like General Motors (GM) and Ford Motor Company (F) have seen their share prices stagnate, despite the fact they continue to perform well.
Both companies are highly profitable, and have drastically improved their cost structures and balance sheets in recent years.
In 2016, GM’s revenue and adjusted earnings-per-share increased 9.2% and 22%, respectively.
Meanwhile, Ford’s revenue rose 1.5% last year. Its earnings fell 2%, but the company still generated more than $10 billion in pre-tax profit in 2016.
Market participants are concerned that the booming auto sales of the past few years are about to come to a screeching halt. There is great uncertainty over the impact that higher interest rates and higher oil prices will have on GM and Ford moving forward.
As a result, both stocks are dirt cheap. On a forward basis, GM and Ford trade for price-to-earnings ratios of 5 and 6, respectively.
Plus, their stagnating share prices has pushed up their dividend yields. GM has a current dividend yield of 4.4%, while Ford yields 5.2%.
Therefore, value and income investors have reason to view Ford and GM favorably, if they are willing to look past the present uncertainty.
Riding out times of uncertainty, while holding onto stocks and resisting the urge to sell out, is no easy task. When stocks decline, it is very tempting to simply bail out of the market altogether.
But while this decision might give us a dose of short-term psychological relief, it comes at a great long-term cost. That is, selling robs investors of the magic of compounding.
And, the effects of compounding are even greater, when buying top-quality stocks at lower prices. Buying cheap stocks helps magnify future returns, by providing stronger capital gains, and higher dividend yields.
Therefore, one could view buying stocks in times of uncertainty, as a wealth transfer from the impatient to the patient.