New Dividend Stocks: Can Meta and Salesforce Help Revive the Classic Strategy?

Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights. Meta and Salesforce will soon pay their first dividends. What shareholders can expect, and could these mega-cap tech stocks help revive dividend investing? Plus, why Morningstar is confident in Adobe’s future despite the software company’s cloudy forecast. And, Morningstar’s senior US economist weighs in on the Federal Reserve’s latest message about interest rates. This is Investing Insights.

Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started.

Adobe’s Strong Q1 & Disappointing Forecast

Adobe reported a strong first quarter but with a confusing and disappointing forecast. Management declined to reiterate its full-year outlook for net new annual recurring revenue. The software company is likely setting up to earn more digital media revenue in the second half of the year. Investors could view this as a risky strategy. The guidance overall came across as confusing. First-quarter revenue grew 12% year over year in constant currency to over $5 billion. That exceeded the top end of Adobe’s outlook. Revenue performance was solid and better than anticipated, with notable strength in digital media. And within digital media, Morningstar thinks Creative Cloud and Acrobat will do well this quarter. Adobe has had better subscriber growth and good consumption within Firefly for enterprise customers in Creative, and strong mobile and Acrobat Sign performance. With recent pricing changes that will soon roll out, pending product launches, and generative AI adoption, Morningstar is not changing its view on Adobe. Morningstar thinks Adobe stock is worth $610. Shares look attractive.

Do Salesforce and Meta Pay Dividends?

Meta & Salesforce will join a new club, dividend payer. The Facebook parent will issue its first quarterly dividend on March 26 and Salesforce on April 11. Meta and the rest of the “Magnificent Seven” have driven the stock market rally, while dividend investing has lagged. So, could Meta and Salesforce becoming dividend-payers help revive the classic strategy? David Harrell is the editor of Morningstar DividendInvestor newsletter.

Welcome to the podcast.

David Harrell: Glad to be here.

Meta and Salesforce New Dividends

Hampton: So, Meta & Salesforce will join other mega-cap tech stocks like Apple and Nvidia in paying dividends. Why now?

Harrell: Well, as you know, a profitable company can do multiple things with their earnings. They can reinvest those dollars in the business itself. They can pay down debt. They can make acquisitions, or they can return cash to their shareholders. Now, there’s two ways a company can return cash to shareholders. They can do it indirectly by buying back their own shares, or they can do it directly by making a dividend payment, either a special one-time dividend payment, or in the case of both of these companies, initiating a quarterly dividend and returning cash that way.

As far as to why these companies chose to initiate dividends now, I mean, there’s a couple of factors here. One is initiating the dividend is sort of making a statement that we’re a mature company, confident in our ability to pay out this cash on an ongoing basis. Another factor is this idea that you’re going to open up your shares to more potential investors. Many institutional investors have a mandate they can only purchase the shares of dividend-payers. So, they wouldn’t have been previously able to own either of these stocks. And there are also some individual investors who have a preference for owning dividend-payers. So, you are widening your potential shareholder base there by declaring a dividend. And then also there might be a tacit admission here that there are fewer high-growth opportunities left for your company. And so, certainly companies in the growth stage are continually reinvesting in their business. As companies mature, there’s fewer opportunities for them. So maybe devoting some of that cash to dividends is a signal that maybe the higher-growth areas, there aren’t as many of them as there were there before. Certainly, particularly in the case of Meta, the market reacted positively to this news. Again, it came in conjunction with an earnings beat, but the stock has certainly popped up since the announcement.

What Can Meta and Salesforce Shareholders Expect?

Hampton: Can you talk about what Meta and Salesforce shareholders can expect?

Harrell: Sure. Well, you gave the dates. If you own these stocks after those dates, you’re going to see either a dividend check in the mail or it’s going to show up as cash in your brokerage account. You could spend that money. You could reinvest it into more shares of those stocks, or you could deploy it elsewhere. I think it’s important to point out though that with both companies, the dividend rate is relatively small. So, it’s going to translate into a yield of around 0.4, I think right now with Meta’s share price, around 0.5 for Salesforce. So, these stocks will have a yield going forward, but generally, it’s going to be below the type of yield that most income-seeking investors are looking for.

Will Meta and Salesforce Diversify the Pool of Dividend-Paying Stocks?

Hampton: And you mentioned mature businesses, so utilities and banks are better known for paying dividends instead of growth companies. Will Meta and Salesforce help diversify the pool of dividend-paying stocks?

Harrell: Well, by definition, they do, because now you have two very large-cap, very large-cap with Meta Platforms, that are paying dividends. But I think in terms of what we traditionally think of as the pool of dividend stocks, the higher-yielding stocks, stocks that are yielding more than the broad market, the overall US market’s yielding a little less than 2%. So, most income-focused investors are looking at stocks that are yielding probably more than that. So, by definition, it’s diversifying the pool or increasing the pool, but I don’t think that either of these stocks are now going to be considered by most investors as a “dividend stock.”

Mega-Cap Stocks and Dividend Investing

Hampton: Got you. So last year dividend stocks lagged the overall market, while the Magnificent Seven drove the rally. Could mega-cap tech stocks help revive dividend investing, David?

Harrell: Well, I mean, a couple of thoughts here. First of all, I’m not sure if dividend investing needs to be revived. So, there’s always this horse race. You look on a calendar year like, well, the broad market did this and dividend stocks did that. And any time that you’re investing in the subset of the market—companies that are paying larger dividends, higher-yielding companies, it’s a subset of the company—you’re going to see in almost any given year some divergence there. So, either dividend-payers are going to lag the market or they’re going to do better than the broad market. And it really often comes down to what are the types of stocks or where are you finding your dividend-payers? For the most part, your dividend-payers are coming from the value column of the Morningstar Style Box. And they also tend to come from the sectors that you mentioned—utilities, real estate, the REITs, some of your consumer defensive stocks.

So, when both from a sector and a style standpoint, those types of stocks are doing well, dividend stocks are going to do well and they’re going to do well relative to the broad market. And when you have a more growth-oriented environment as we’ve had recently, certainly in 2023, dividend stocks are going to lag. But at the same time, dividend investors aren’t necessarily focusing on this horse race on a monthly or an annual basis like, well, are dividend stocks lagging the broad market or outperforming the broad market? Most of those investors, I believe, are focused on getting that yield from the portfolio. So, they’re getting the yield and generally hopefully getting some capital appreciation as well. So, as long as those yields are remaining strong for their portfolios, I don’t think it’s necessarily a concern. And I have talked—because we’ll talk about that—dividends have outperformed or underperformed the broad market, and I think for many dividend investors, as long as they’re seeing their dividend income stream remain strong and growing, that whether or not you’re outperforming the broad market or keeping up with the broad market is a little less important at that point.

And just to go back to your last question, the Magnificent Seven, prior to Meta’s announcement, you mentioned a couple of them, but we actually had three of the Magnificent Seven stocks that were dividend-payers. Microsoft, which initiated a dividend back in 2003, I believe, a regular quarterly dividend in 2003. Apple initiated a quarterly dividend in 2012, I believe. And Nvidia has been paying a dividend for a while, but the yield there is just—it’s microscopic—it’s like 0.02%, whereas I think Microsoft is yielding around 0.7%. Apple is yielding around 0.5%. So at least, the two larger names are longtime dividend-payers, and they have grown their dividends, but certainly not at a rate that’s kept up with some of the share price appreciation we’ve seen.

So, at this point, we can say that four of the seven stocks that are considered the Magnificent Seven are dividend-payers, but it’s probably not an area that most income-focused investors are going to when looking for yield. So, again, I think, not a lot has changed in terms of the investment outlook for these firms. As a prospective investor, you want to consider, gauge your confidence in the business, the business model, the moat, and then the valuation of the stock. And certainly, the dividends are not a bad thing. And I think definitely in the case of Meta Platforms, the Morningstar equity analyst was praising them for initiating a dividend, but it’s probably not a big factor for most investors. And certainly, we’d have to see either a really large increase in the yield or the yield equation—the other way to see it, a large increase in the dividend for the yield to go up or a large decrease in the share price, which certainly not a thing anyone is hoping for. But looking at long-term for both of these stocks, Morningstar analyst’s projections for their dividend growth still shows their yield four years from now well under 1%. So, again, as you said earlier, it is diversifying the pool of dividend-payers or increasing the pool of dividend-payers, but these aren’t stocks that I’m expecting that many income-seeking investors are now going to seek out.

Hampton: Well, David, thank you for coming to the table and breaking down what investors should know.

Harrell: Thanks for having me.

Why We Think 5 Interest-Rate Cuts Are Coming in 2024

Hampton: The Federal Reserve is holding off cutting interest rates for now, like expected. Sticky inflation is raising questions about whether the road to the Fed’s 2% target will be a bumpy one. So, what should investors expect? Senior US economist for Morningstar Research Services Preston Caldwell is here to provide his insights. Thanks for joining me, Preston.

Preston Caldwell: Hey, Ivanna. Thanks for having me.

Will Interest Rates Drop in 2024?

Hampton: The Federal Reserve kept their forecast for three rate cuts this year. What do you think the Fed needs to see to feel confident about lowering its benchmark rate?

Caldwell: It was kind of an uneventful meeting. So, markets had known with high confidence for the last couple of months that the Fed was not going to cut in this meeting. Just given that Powell had kind of thrown cold water on the notion of rate cuts in its last meeting, and also we had an uptick in inflation in January’s and February’s data. So, the results of the meeting were set in stone. Investors, if anything, were just cluing in on whether the Fed’s projections would change, and they really haven’t changed much. Despite the uptick in inflation, and that did cause the Fed’s fourth-quarter 2024 inflation forecast to tick up slightly to 2.6% year over year from 2.4% previously, nonetheless, we, as you mentioned, didn’t have any change in the Fed’s rate-cut forecast for 2024. Still expecting three rate cuts, even though I think a few voters may have changed their views, but the median expectation is still three rate cuts. And I think that’s just because the Fed is still pretty even-keel in its assessment of inflation. It’s not drifting as much as the market is in either a pessimistic or optimistic direction just based on the latest data. It’s more looking at the very long-run trend, which is to say that inflation is coming down. It’s been a bumpy road, as Powell noted, but it is making progress to 2%. As that happens, it will eventually be appropriate to cut rates this year.

When Will the Fed First Cut Interest Rates?

Hampton: And you forecast six cuts in 2024. What’s your thinking now? And when do you predict the first interest-rate cut?

Caldwell: About a month ago, I had changed my forecast actually. I had originally thought there would be a cut in March, and six rate cuts altogether in 2024. But a little over a month ago, I changed that forecast to five rate cuts just based off the inflation data coming in higher in January and February. With that said, I’m still expecting five rate cuts this year, with the first one coming in either the May or most likely the June meeting. Because I do think, despite the uptick we’ve seen in the last two months, overall inflation continues to trend down. It was in the second half of 2023 at just 1.9% in terms of core inflation. Now on a year-over-year basis, that core inflation rate remained at 2.8% as of February. So, we’re not quite down to 2.0% yet, but we’re drifting in that direction. And I think not only will we continue to see relief in terms of goods prices coming down, which has helped to drive inflation down greatly over the last year, but we’ll also start to see progress on housing inflation coming down, which the leading-edge data still indicates quite strongly that will happen. And so ultimately, I think that will add up to the Fed cutting five times this year and also cutting more in 2025 than the Fed currently expects. So, altogether by year-end 2025, I think the federal-funds rate will come down to 2.25%, which is actually 150 basis points below what the Fed is currently projecting. And that’s based off of our greater optimism on inflation coming down.

Federal Reserve’s Longer-Term Outlook

Hampton: Now interest rates set near zero before the pandemic. What has the Federal Reserve signaled about their longer-term outlook for rates?

Caldwell: For quite a while, they’ve been at 2.5% as their long-run expectation for the federal-funds rate. And then I think in this last meeting, it ticked up to 2.6%. So, I wouldn’t read much into that minor adjustment, just a few people revising their long-term forecasts. But we should watch it and see if it becomes a trend. It would be interesting to see if the Fed does start to bake in a higher-expected long-term interest rate. Before the pandemic in the post-global-financial-crisis environment, we had interest rates much lower than historical levels. But actually, it’s really been a four-decade-long trend to lower interest rates driven by factors like demographics and lower productivity growth. So, all that suggests that the environment of low interest rates that was prevailing prior to the pandemic is not a cyclical or temporary development but is a long-term development. And so, it would require shifting those long-run trends if we were going to see a new higher for longer, a new normal of higher interest rates. So, our view is that really interest rates eventually settle back down about to where they were before the pandemic. And that’s still basically what the Fed is baking in as well.

Hampton: Well, Preston, thank you for your insights and your time today.

Caldwell: Thanks, Ivanna.

Hampton: That wraps up this week’s episode. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends, and analyst insights. Thanks to senior video producer Jake VanKersen, lead technical producer Scott Halver, and associate multimedia editor Jessica Bebel. And thank you for watching Investing Insights. I’m Ivanna Hampton, a lead multimedia editor at Morningstar. Take care.