Interest rates have been falling for years, driving stock prices up, and reducing the dividend yields for many classic dividend payers. Over the long term, the compounding value of income equity stocks is a function of both beginning yield and the growth of yield over time. The low starting yield relative to history combined with slow growth leaves us less than enthused about most of the stocks in the utilities, consumer staples and real estate sectors. Naturally there are exceptions, but relative to our broad universe, we have recently found better opportunities in sectors with higher growth.
Mature technology companies offer excellent prospects for both yield and growth of yield. Fluctuating demand for personal computers and mobile phones used to make this a highly cyclical sector. It's hard to rely on a stream of dividends that's dependent on nailing the "next big thing." The industry has now diversified dramatically. Semiconductors and software are literally everywhere, from factory floors to autos to the video doorbell I just bought for our home.
Management teams at some leading tech companies have acknowledged the industry's newfound stability by announcing large dividend increases. As examples, the most recent dividend increase at Cisco was 14% and at Texas Instruments it was 24%. Even larger was the 27% dividend increase announced by KLA Tencor.
Banks and insurance companies also have the potential for superior dividend growth. Lower interest rates have depressed what financial firms can earn on loans and other assets. Given recent commentary out of the Federal Reserve, short-term interest rates are likely to continue rising. The tightening labor market, faster economic growth and some hints of inflation point to rising long-term rates.
Higher interest rates should boost earnings for financial companies, leading to higher dividend payouts. Banks in particular have plenty of capital and regulators have been allowing healthy dividend increases in recent years. Regional banks are in the best position as Congress is crafting legislation that would reduce regulations for midsized banks. As a couple of examples, BB&T raised its regular dividend 10% over the last year plus paid a special. Huntington Bancshares increased its dividend 37%. No one would expect that type of increase year after year, but compounding double-digit increases for only a few years can raise yields dramatically.
The landscape is changing for income-equity stocks. Investors chasing yield have bid up the share prices for many utilities, consumer staples and real estate stocks—pushing down their yields. With few exceptions, growth in these sectors looks tepid, suggesting yields will rise slowly from a lower starting point. Leaning towards dividend growth is the best cure for lackluster yields. The good news is that some technology and financial companies have raised their dividends significantly and have the potential to continue that growth at a good clip driven by superior industry tailwinds.
