Does the S&P 500 favour growth over income? Are there still opportunities for the income investor? And what should UK investors be aware of when entering this market?
Over the following pages, the IC’s specialist writers profile the 10 largest constituents of the S&P 500 by market capitalisation with dividend yields of 4 per cent or more. Some of these companies are so-called ‘dividend aristocrats’ with 25 consecutive years of annual dividend increases and higher returns and lower volatility than the main index.
Covering comparable sectors to the UK income majors, including oil and gas, telecommunications, tobacco, technology, pharmaceuticals and real estate, these companies provide a barometer for the US dividend case and illuminate the opportunities (and pitfalls) the S&P 500 has to offer.
S&P 500: growth versus income
The S&P 500 contains some of the largest companies and conglomerates in the world. However, many of the biggest names pay a meagre dividend, if at all. Visa (US:V) paid a dividend of $0.825 per share in 2018, representing a yield of less than 1 per cent. Despite receiving $3.8bn in dividends last year, Berkshire Hathaway (US:BRKB) itself has not declared a dividend since 1967.
This reflects the general preference of US companies and equity investors for growth rather than income. According to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, “dividends were historically richer in the US, but have lost their grandeur in the past 30 to 40 years as capital appreciation became much bigger.” Discretionary buybacks are favoured over dividends as a means of returning capital to shareholders as companies can simultaneously boost their valuations. Turbocharged by the US Tax Cut and Jobs Act, S&P 500 companies purchased $806.4bn of their own shares in 2018. Silverblatt predicts buybacks could reach $1 trillion in 2019.
So, is there a place for income investors on the S&P 500?
Since 1926, dividends have contributed a third of the S&P 500’s total return, and total dividends surged by 8.7 per cent to a record $456.3bn in 2018. Currently, 418 companies listed on the index pay dividends. But following the exceptional boost from the tax cut, dividend growth has predictably slowed in the first quarter of 2019. Based on current payout policies, Silverblatt expects dividends to increase by 5.4 per cent for FY2019 marking an eighth consecutive record year.
However, even unprecedented dividends have been outpaced by earnings growth. Dividend payouts (dividends as a proportion of earnings) have fallen below the long-term average of 51 per cent.
With the focus on higher valuations, yields remain low. In the first quarter of 2019, the yield dropped to 2.01 per cent, below the historical average of 3.6 per cent. By comparison, Link Asset Services forecasts that FTSE 100 companies will produce a dividend yield of 5 per cent in 2019, superseding its 30-year average of 3.5 per cent.
Fears that the US economy is heading towards a recession could send investors fleeing from growth-orientated stocks towards reliable dividend-payers. As the infamous yield curve continues to flatten and long-term bond yields decline, dividend-paying stocks are becoming more attractive. Dividends are less volatile than earnings, so income-orientated equities offer solid defensive positions to anchor your portfolio during periods of uncertainty.
With persistent domestic uncertainty, UK investors might also consider the benefits of diversifying their portfolio to include dollar-based income.
Things to bear in mind
- Elevated debt levels. According to the Wells Fargo Investment Institute, the cash balances of non-financial S&P 500 companies exceeded $1.6 trillion in 2018. However, corporate debt stood at $5.3 trillion, 3.3 times the cash balance. This raises serious questions about the sustainability of dividends on offer and the threat of dividend cut traps. We will be examining whether companies have sufficient earnings to cover their debt and adequate free cash flow to sustain dividend payments.
- Tax implications. Individual UK investors must submit a W-8BEN form (valid for three years) with a broker who is approved as a qualified intermediary by the US Inland Revenue Service. If shares are held within an individual savings account (Isa), a reduced withholding tax rate of 15 per cent is applied to US dividends. As a qualifying pension scheme, dividends within a self-invested personal pension (Sipp) should be free from withholding tax. You can check this with your platform or provider.
|US Income Majors|
|TIDM||Name||Industry||Mkt cap||Share price||Fwd PE (x)||Dividend yield||CapIQ DY||EV/Ebit||EV/sales||P/BV||Dividend cover||3-mth momentum||Net debt/Ebitda (x)|
|NYSE:XOM||Exxon Mobil||Integrated Oil and Gas||$340bn||8,034¢||18||4.00%||4.10%||13.2||1.4||1.77||1.51||18.20%||0.88|
|NYSE:T||AT&T||Integrated Telecom Services||$229bn||3,140¢||9||6.40%||6.50%||13.1||2.4||1.24||1.44||9.60%||3.05|
|NYSE:PM||Philip Morris Int.||Tobacco||$135bn||8,703¢||16||5.20%||5.20%||14.2||5.5||-||1.15||30.60%||2.04|
|NYSE:IBM||Int. Business Machines||IT Consulting and Other Svcs||$124bn||13,924¢||10||4.50%||4.50%||12.9||2||7.4||1.54||23.90%||2.03|
|NYSE:SLB||Schlumberger||Oil and Gas Equipment and Svcs||$59bn||4,268¢||27||4.70%||4.70%||22.8||2.3||1.63||0.77||17.90%||2.23|
|NYSE:SPG||Simon Property Group||Retail REITs||$56bn||18,111¢||25||4.40%||4.50%||23.5||14.1||17.2||1||8.30%||5.42|
|Source: Capital IQ, data correct as of 28 March 2019|