Dividend-paying stocks suffered a tarnished reputation in recent years. Throughout much of the low-inflation, easy-money environment of the past decade, investors eschewed yield providers in favor of high-torque growth stocks, especially in technology-focused fields. It was a classic case of investors thronging to the shiny new thing.

“During the bull market of the last decade, people were forecasting what some of these newer, more innovative companies might look like one day. They were paying a lot for potential future earnings and revenue. This high valuation was also supported by low interest rates,” explains Aline Avzaradel, a Capital Group equity portfolio manager. “By contrast, a company that’s consistently paying and growing a dividend is already profitable, more mature and established. It’s just not likely to rapidly expand, and those types of companies were not in favor.”

There are clear signs that the wheel is turning. Dividend-paying stocks have held up better than the broader market in recent months, the beneficiaries of investor demand for less volatile securities that can weather a variety of market conditions. Meanwhile, growth stocks have been muted, as they can be challenged in high-inflation and high-interest environments. Overall, dividend payers could be well placed to provide appealing returns over the next several years, Avzaradel believes.

Of course, dividends aren’t a cure-all for portfolios in search of stability. Income-generating stocks can be affected by the same value fluctuations that have bedeviled the rest of the market this year. And yields aren’t an automatic guarantee of a strong balance sheet or a reliable payment schedule. Still, when they’re found in conjunction with other virtues, such as a strong management team and disciplined capital allocation, income-producing stocks can help provide some stability to a portfolio.

Higher dividend yields have contributed to better downside resilience

Sources: Capital Group, based on data from Morningstar. Funds include those from the Morningstar Open-End Large Growth, Large Value and Large Blend categories. Downside capture quartiles calculated using three-year down capture ratios compared to the S&P 500 Index.

Dividend payers have often combined downside resilience with strong long-term results.

This year’s momentous events have cast a long shadow over markets. The Russian invasion of Ukraine is the largest war in Europe since World War II, and it has caused havoc with energy and commodity markets around the world. Inflation has continued to march upward, showing only occasional signs of relenting as it hovers at multidecade highs. And, of course, COVID-19 continues to beleaguer economies.

That turbulence has caused many investors to seek less risky securities, contributing to the recent relatively strong results of many dividend-paying companies. In periods of volatility, investors seek companies with more resilient earnings, Avzaradel says, partly because they’re more likely to continue paying and growing their dividend in tough times.

That allure has legs, too, as the Federal Reserve and other central banks are aggressively raising interest rates to combat inflation. Higher interest rates can weigh on the valuations of growth-oriented businesses because they discount future earnings.

“The Federal Reserve has clearly said it will continue to tighten its policy to bring inflation under control,” Avzaradel notes. “It can’t do that without the economy slowing down. In that scenario, I think reliable dividends can help on the downside.”

However, dividend payers aren’t simply recession stocks; they also have had attractive risk-adjusted returns over the long term. With dividends reinvested, they outpaced their non-dividend-paying counterparts on an average annual basis over a 50-year period examined by Capital Group analysts. Similarly, they tended to fall in value less than the broader market when conditions soured. Of course, the flip side is that dividend payers have tended to lag the market during powerful upswings, with their more volatile counterparts having raced forward in those periods.

Not all dividends are the same.

Though yield-bearing equities enjoy the perception of stability, it’s important to note that there is a constellation of dividend payers, Avzaradel says. High yields may look attractive on paper, but they can be a red flag for an unsustainable payout.

“After a certain point, when stocks reach a very high yield level, the percentage of companies that cut their dividend jumps,” she explains. “Often, the market is telling you something about those companies. My research has shown that, historically, the highest-yielding quintile had worse results over time than the other yield quintiles. Over really long periods of time, the middle yields — those in the 1% to 3% range — have often done best.”

Rather than reaching for yield, Avzaradel prefers businesses with a history of honoring and growing dividends. Additionally, she stresses that investors have to analyze the circumstances of a dividend’s growth — small token increases can signal stagnancy, for example. 

At the moment, Avzaradel says, she’s finding interesting opportunities with dividends in the health care and utilities sectors, as well as the insurance industry.

“I’m looking for more defensive yields at this point,” she says. “But we are also starting to get investment opportunities in some companies with very attractive long-term outlooks that have sold off in the recent market downturn.”