Dividend Hikes Beget Share Price Spikes
My IDEAL stock-rating system uses dividend yield and cash flow as two of its three components for good reason. Over the long haul dividends account for roughly half of the stock market’s total return, and companies with improving cash flow are better able to raise their dividends while also having money left over to invest in the growth of their businesses.
After the Great Recession eight years ago, the stock market became fixated on growth as the Federal Reserve kept interest rates artificially low. But now that rates are rising and bond prices are tanking, dividends are making a comeback, based on the behavior of stocks that are raising their payouts while remaining profitable.
A couple of recent examples illustrate just how beneficial an escalating dividend payment can be to share price performance. Last week Personal Finance Growth Portfolio holding Eastman Chemical (NYSE: EMN) raised its quarterly dividend 11%, the seventh straight year the company has increased its annual payout. That pushed the share price above $76, up 20% from just two months ago.
This week The Buckle (NYSE: BKE), a stock recommended by our Systematic Wealth trading service a month ago, declared an annual special cash dividend of 75 cents per share in addition to a regular quarterly dividend of 25 cents, resulting in a quick 5% jump in its stock price. Like Eastman Chemical, The Buckle’s share price is also up 20% over the past two months.
Of course, the stock market has been on the upswing recently, increasing 3% the same time that Eastman Chemical and The Buckle each gained 20%. So clearly, companies that are up more than six times the change in the index must be benefitting from more than just a favorable tailwind. I believe this extreme outperformance is mainly due to a phenomenon I first described early this year after the Fed raised interest rates for the first time since the Great Recession eight years ago.
For the past 30 years bond prices have increased as interest rates dropped, enabling income investors to have their cake and eat it too in the form of cash flow plus capital appreciation. But when interest rates start heading back up, bond prices will drop, and investors will be forced to choose between cash flow from interest payments and capital losses as bond prices fall. Because most people don’t like seeing their portfolio values decrease, many bondholders may switch to high-yielding stocks to avoid losing money in bonds over the next decade.
Although the stock market is just as likely to go down as it is to go up in the short run, over the long haul it is a near certainty to appreciate. The same cannot be said of bonds. As long as interest rates continue rising, bond prices will most likely fall because bonds offer no growth potential. Experienced bond investors know that interest rate cycles are extremely long term in nature. The last time that rates cycled upward was after World War II, and they didn’t peak for another 35 years. For those three and a half decades, bondholders took a drubbing.
That doesn’t mean the same thing will happen this time, but it suggests holding a portfolio of fixed-rate bonds could become considerably less lucrative than putting the same money into high-quality stocks with a history of increasing dividend payments. I believe that is where some of the extra juice is coming from to energize companies like Eastman Chemical and The Buckle, and it is probably the beginning of a trend that will continue into next year and beyond.
Fortunately, you don’t have to look far to find several high-quality stocks that should meet your need for current income while also providing long-term share price appreciation. Our PF Income Portfolio yields 4.4% on average from an elite group of companies that score highest according to our SHIELD stock-rating system. If you currently own bonds, you may want to see which high-yield stocks we rank highest so you can maintain your cash flow while avoiding the near certain losses that most bonds will deliver to investors in the years to come.