Searching for Yield — Evening Brief – 10.24.24
Things are going well for the third quarter earnings season so far, with the major money center banks reporting strong results. The continued capital investment in artificial intelligence has also stoked growing expectations that the technology sector will provide strong sales and earnings.
Furthermore, the Atlanta Fed has revised its growth rate for the third quarter to 3.4%, from a previous estimate of 2.5%, indicating they perceive the recent half-point interest rate cut by the Federal Reserve as positive for corporate profitability.
Consequently, numerous stocks currently have dividend yields that compete with Treasurys or investment-grade corporate bonds. The primary advantage of dividend income over equivalent fixed income yields is in the tax treatment. Fixed income is subject to taxation as ordinary income, according to the investor’s tax bracket. The highest rate imposed on qualifying dividends is 20%. The maximum federal income tax rate is 37%.
A bond yielding 4% for a high-income earner results in a net yield of 2.52%, while a qualifying dividend yielding 4% provides a net yield of 3.2%. This is a significant difference when accounting for inflation.
The primary obstacle for investors pursuing high dividend yields is that dividend growth has not matched market performance. Dividend yields from blue-chip U.S. corporations have been declining, as indicated by the S&P 500 Index dividend yield of roughly 1.78% at the end of 2022, and presently at 1.21% for the SPDR S&P 500 Index ETF (SPY), which is far below the index’s long-term average yield of 2.91%. Dividend yields have consistently stayed low (below 3%) since 1992.
According to Aswath Damodaran, professor of finance at Stern School of Business at NYU, the average dividend yield from 1970 to 1990 was 4.21%. Between 1991 and 2007, it decreased to 1.95%. The annual S&P 500 dividend yield averaged a mere 1.98% from 2009 to 2019, following a brief surge to approximately 3.15% during the 2008 Great Recession. The dividend yield has fluctuated between 1.24% and 1.78% since 2020.
Looking at the S&P 500’s 11 sectors, the top yielding sectors are the Utilities Select Sector SPDR ETF (XLU), paying 2.79%, and the Consumer Staples Select Sector SPDR ETF (XLP), paying 2.58%; hence, ETF sector investing cannot satisfy the criterion for qualified dividend yields. There are just a few companies in which a portfolio of dividend stocks may be created, such as Verizon Communications, Inc. (6.30% yield), AT&T (5.20% yield), and Prudential Financial, Inc. (4.20%).