Where to Invest for Income

Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Dan Lefkovitz. He is a strategist at Morningstar in Chicago.

Hello.

Dan Lefkovitz: Hello, Holly.

Black: I think dividends have been on the minds of a lot of investors this year, mostly because they keep getting cut. But you've done some research, and you're saying it's not such a bad time to be an income investor after all.

Lefkovitz: You know, Holly, it's undeniably been a difficult year for equity-income investors around the globe. We've seen some big dividend stalwarts cut their dividends. Royal Dutch Shell lowered its dividend payment for the first time since World War II. In Australia, three of the big four banks cut their dividends; some blue-chip names in the U.S. market like Disney and Boeing. But plenty of companies have maintained their dividends, and that doesn't make the headlines. Bad news is always a better story than good news. And if we look globally at equity markets, we see plenty of healthy, even rising shareholder payouts. The pain has really been felt most acutely by the areas that are most exposed to the pandemic-related shutdowns and economic slowdowns, so travel and leisure, the airlines, consumer discretionary, oil and gas, and basic materials have been hit hard by dividend cuts. In the U.S. market, small caps have really borne a big brunt of the blow.

Black: You run these indices that specifically pick out companies that are still growing their dividends. So if they cut, they're out. So, you must be fully aware of the areas of resilience. What sorts of sectors are holding up better this year?

Lefkovitz: When we did some index rebalancing in June, there were indeed a number of dividend payers that had to be removed from these indexes because the companies indicated suspensions of the dividends, largely in the areas that I mentioned. But it wasn't major upheaval. The turnover wasn't excessive, and there are definitely plenty of areas where we are finding healthy payouts.

I'd point to consumer staples as opposed to consumer discretionary, so more-defensive names like Procter & Gamble and Costco, Nestlé and Danone, and Kao in Japan. Healthcare and technology, which are two areas that are not necessarily known for being dividend-rich, but in Big Pharma we see some healthy dividends--Bristol Myers, Sanofi, Novartis--within technology, Microsoft and Cisco, ASML, SAP, Taiwan Semi. Industrials names like 3M and ABB. And then financials, which has been an area where we've seen plenty of dividend cuts, many of them mandated by regulators as a condition of aid. Our dividend indexes seem to favor the Canadian banks, JPMorgan, the credit card companies like Visa and Mastercard. And all of these companies that I'm citing are ones that Morningstar equity analysts believe have economic moats or sustainable competitive advantages that should allow them to sustain profitability and dividends as well.

Black: You're right. When you say it like that and list all those companies, it doesn't sound so bad. So, for any investors that are still panicking about their income and the dividend cuts, what would be some words of advice for them?

Lefkovitz: Well, we'd be leery of the highest yielders in the market. Those are often companies that are in financial distress, they are dividend traps in many cases. The dividend might not be sustainable, and you can end up sacrificing long-term total return at the expense of short-term income. And then, we tell investors not to get too hung up on dividend history. As Shell showed us this year, a decades-long track record can only get you so far. We'd look instead for factors that we think are predictive of dividend sustainability and dividend growth going forward. Dividend growth can be the sign of healthy and improving corporate fundamentals.

Black: I do love that point of it doesn't matter if this company's paid a dividend for 50 years; it didn't this year, so find one that is. And you've found there are plenty of options for people.

Lefkovitz: Right.

Black: Dan, thank you so much for your time. For Morningstar, I'm Holly Black.

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