Why Long-Term Investors Should Consider Dividend Stocks – Guest Post
Scott @ Two Investing: Today’s post is a guest post from our friends at Sure Dividend about the benefits of dividends stocks to a long-term investor. Without spoiling the ending, I love their example dividend paying stock. It’s in the biotech space and not only pays a great dividend but has the benefit of growth as well. Another benefit to dividend investing in the time of COVID-19 is that it is a way to get better yield than the 10-year treasuries while being seemingly backstopped by a Fed willing to spend whatever it takes to keep the money flowing. The large technology stocks like Apple and Microsoft have a ton of liquidity and a large enough market cap for billions of dollars to trade without moving the needle much, the exact things that large hedge funds look for to park money. Dividend paying stocks are just the thing that will benefit from a low treasury yield.
Now, on to our guest post. Enjoy! Please let us know what you think in the comments. Scott
Why Long-Term Investors Should Consider Dividend Stocks
After a massive decline to begin 2020, the S&P 500 Index has roared back to its pre-coronavirus levels. In bull markets, it is tempting to view the stock market as a place to gamble. Watching the financial media can only add to this misconception. But investors who obsess over the daily fluctuations of stock prices are missing the bigger picture.
Instead of viewing stocks like lottery tickets, investors should understand that buying stock in a company is essentially buying a small piece of it. Shareholders are the owners of a business. For this reason, we recommend investors take a long-term view when investing in the stock market.
At Sure Dividend, we believe investors can generate superior long-term returns by buying and holding high-quality divided stocks such as the Dividend Aristocrats, a group of 65 companies in the S&P 500 that have raised their dividends for at least 25+ consecutive years.
This article will discuss the importance of investing in stocks with sustainable dividends, along with an example of a Dividend Aristocrat with a sustainable payout and long-term growth potential.
Why Income Investors Should Focus On Quality
When it comes to income investors, too much focus is given to stocks with the highest dividend yields. It is possible to find extremely high dividend yields of 10% or more, but in many cases such high yields are actually a sign of impending danger. A stock price and its corresponding dividend yield are inversely related, meaning a declining share price sends a dividend yield higher. For example, if a stock is priced at $100 per share and pays a $1 per-share annual dividend, the stock will have a 1% dividend yield. If this same stock declines to $50 per share and keeps paying its $1 dividend, the yield now rises to 2%.
Stocks with abnormally high dividend yields in the double-digits are usually distressed companies whose share prices have collapsed. This is typically due to a deterioration in the company’s underlying business fundamentals. The danger for investors is that the extremely high dividend yield can vanish in an instant if the company cuts—or worse, eliminates—its dividend payments in an effort to preserve cash. Many companies across multiple industries, such as airlines, restaurants, and the energy sector have announced dividend cuts or suspensions in 2020, due to the coronavirus pandemic.
Dividend cuts are typically accompanied by a further decline in the share price of a stock, which is why investors want to avoid these dividend traps at all costs. As a result, investors should focus less on dividend yield, and more on sustainability of the dividend payment as well as room for future dividend growth. This is where the Dividend Aristocrats come in.
The Dividend Aristocrats are a group of stocks that have each raised their dividends for at least 25 consecutive years. This period of time has included multiple recessions and other difficult periods. And yet, the Dividend Aristocrats have increased their dividends regardless of the economic environment. Such a long history of annual dividend hikes indicates a business that is resilient to recessions, with durable competitive advantages that lead to long-term growth in profits and dividends.
The following stock is an example of a Dividend Aristocrat that has a high dividend yield, but more importantly a secure dividend payout with plenty of room to continue increasing its dividend each year.
Dividend Aristocrat For Secure Payouts: AbbVie Inc. (ABBV)
AbbVie is a pharmaceutical company focused on Immunology, Oncology, and Virology. AbbVie was spun off by Abbott Laboratories in 2013. It qualifies as a Dividend Aristocrat because its former parent company was on the list, and Abbott remains a Dividend Aristocrat as well. AbbVie has grown at a high rate since its spin-off, thanks largely to its flagship multi-purpose drug Humira, which by itself represents ~60% of annual revenue.
Investors should always be aware of risks when investing in the stock market, and AbbVie is no different. Its principal risk is the loss of patent exclusivity on Humira. The drug already lost patent exclusivity in Europe, which has caused AbbVie’s international sales to suffer. However, Humira continues to generate strong results domestically. In the 2020 first quarter, AbbVie’s revenue of $8.6 billion increased 10% year-over-year, while adjusted earnings-per-share increased 13% to $2.42. Global Humira net revenues of $4.7 billion increased 6.4% operationally.
And while Humira will lose patent protection in the U.S. in 2023, AbbVie is well-prepared. The company has invested heavily in building its future pipeline, and the investment is already paying off. For example, AbbVie’s hematologic oncology sales increased 32% last quarter, to $1.549 billion. AbbVie has received 14 major approvals since 2013, with 10 of those coming in the core categories of Immunology and Oncology. AbbVie has multiple growth opportunities to replace Humira. AbbVie has seen strong growth from Imbruvica, which saw a 21% increase in sales last quarter.
Future growth will also come externally, from acquisitions such as the massive $63 billion takeover of Allergan (AGN). Allergan’s flagship product is Botox, which diversifies AbbVie’s portfolio with exposure to global aesthetics. The combined company will have annual revenues of nearly $50 billion. AbbVie expects the transaction to be 10% accretive to adjusted earnings-per-share over the first year, with peak accretion of greater than 20%.
AbbVie has a high dividend yield of nearly 5%. More importantly, the dividend is highly secure, thanks to the company’s strong profitability. Analysts expect AbbVie to earn adjusted earnings-per-share of $10.45 for 2020, meaning the company has a projected dividend payout ratio of 45% based on the current dividend rate of $4.72 per share. This indicates a healthy payout ratio, with room for future increases.
The Bottom Line
When stocks are flying higher, it is easy for investors to forget about fundamentals. And in an environment of zero interest rates, income investors are in a difficult position in the search for yield. But investors need to avoid stocks with unsustainable dividends, and instead focus on quality dividend stocks built for the long run. These companies, such as AbbVie, are likely to generate superior long-term returns through their dividends and future growth.