With interest rates still near zero, the perception is that this is a golden age of dividend investing. In reality, most dividend payers are becoming mysteriously unwilling to cough up much of their cash.
Historically speaking, today’s payout ratios are extremely low. Companies that comprise the S&P 500 devote only about one-third of their earnings to paying a dividend, well below the long-term average. And it’s not like many of those companies can plead poverty. Most have record cash positions and solid balance sheets.
The stringiness among S&P 500 companies is reflected in the index’s current yield, which at 1.9% is less than half the 4.4% long-term average. In fact, if it holds, 1.9% would be the lowest annual yield for the S&P since 2007.
Yes, payouts have grown tremendously since bottoming out after the recession in late 2009. Companies are growing their dividends at 12.4%, more than double the long-term average. But earnings are growing even faster. The 12.4% dividend growth rate actually trails the 15% earnings growth rate by a fairly substantial margin.
Cutting to the chase: Companies have plenty of room to increase their payouts even further.
The good news is, at least one prominent analyst thinks they will – at least as a percentage of earnings.
Rod Smyth, chief investment strategist at RiverFront Investment Group, projects that dividend payouts will climb almost as much in the next five years as they have in the past four. Smyth told Bloomberg that he expects dividends paid out by S&P 500 companies to rise 40% by 2019.
Quick math tells us that a 40% dividend increase in five years comes out to a mere 8% a year, well shy of the current 12.4% growth. However, earnings growth is expected to slow significantly in the coming years. Smyth projects annual EPS growth of just 5% among S&P 500 companies in the next five years. Thus, while overall dividend growth may slow in the coming years, companies will share a much higher percentage of the money they earn than they do now.
What does that mean for individual investors?
If corporate earnings growth is going to slow in the next five years as much Smyth projects, then a higher payout ratio will make dividend stocks more attractive… even with slower dividend growth. Really, it’s all about the payout ratio. According to Smyth’s projections, the dividend payout ratio among S&P 500 companies would increase from roughly 35% to 40% by 2019.
That’s still well off the 56% payout ratio of the 1960s. But 40% would be higher than the average ratio since the turn of the century.
If companies become more generous in their payouts, that should help improve the rather pedestrian 1.9% average yield. That’s a comforting thought given that stocks seems on the cusp of a major long-term correction.
Slower earnings growth may translate to slower share price appreciation. But a higher payout ratio will make dividend payers even more attractive than they have been in the last four years.