“The beauty of dividends is that you get paid, whether or not the market is up.”
~ Howard Silverblatt, Senior Index Analyst with Standard & Poors
Question: What are your thoughts on how interest rate increases, regulatory reforms and tax changes may influence dividend paying stocks?
Answer: Gradually increasing interest rates and the implementation of regulatory and tax changes will likely have some impact on dividend paying stock in the short term.
Why an investor owns dividend stocks needs to be considered. There are two reasons to own dividend payers; capital appreciation (increases in the share price), and for the income. These two when combined equal total return. Because interest rates have been so low for so long, many people who traditionally owned certificates of deposit and bonds have migrated to dividend stocks for the cash flow and income.
What are dividends?
Corporations reinvest earnings or pay them as dividends to shareholders. It is typically the more mature and established companies that pay dividends to reward shareholders, while newer growth oriented companies tend to reinvest their earnings for expansion. Logically, dividend payments of high-quality companies may translate into less share price volatility since you can’t fake cash flow, and that’s what’s necessary for dividend payments. Dividends are often a symptom of a healthy company.
Interest rate increases
For example, shares of stock in a company priced at $100 each pay an annual dividend of $2, which equals a 2% yield. If interest rates continue to rise, this 2% yield may not be as attractive to investors if they could find better returns elsewhere. All things being equal, the share price on the stock could decline to offset rising rates on other investments. But there’s more to the story; additional factors such as growth expectations, balance sheet strength, and a history of increasing dividend payments could benefit our theoretical company in a rising rate environment. This is why there’s usually a place in portfolios for high-quality dividend paying stocks; the amount allocated for this purpose is what differs for each individual.
In addition to interest rate concerns, proposed regulatory policy changes could affect the perception of some dividend paying stocks in the short-run. Since dividends are usually paid by more mature and stable companies to reward shareholders, particular sectors subject to new regulations may come under pressure.
Right now the pharmaceutical industry is in the regulatory spotlight for pricing issues. Price regulation could easily impact certain companies. By knowing the percentage of revenue a company derives from specific drugs subject to these actions investors may better understand the extent of any regulatory influence and make informed decisions. It’s worth noting that many of the drug companies under scrutiny provide generic, off-patent or non-research related drugs.
Meanwhile, it’s expected that regulation for the financial sector may lessen. Reduced regulations could lead to a more business-friendly environment and increased profitability. Lower regulatory expenses may enhance cash flow, which could be made available in the form of dividends to shareholders.
Immigration policy revisions are another area of discussion. Agricultural and farming sectors are most likelyto feel the impact of any changes since they depend on immigrant labor. The effect of labor force changes on more mature dividend paying companies would likely be minimal because this limited labor cost represents a low percentage of overall expenses.
U.S. corporate taxes of 35% are among the highest in the developed world. One of the new administration’s goal is to lower corporate taxes to roughly 20% thereby encouraging some of the $2.5 Trillion being held overseas by U.S. multinationals to be brought home with hopes of ultimately benefiting businesses and shareholders. Some of the repatriated cash could be used for dividend payments. Lower taxes combined with the repatriation of cash held outside our borders is expected to increase expenditures on research, development, corporate investment, and job growth, which could provide additional tax base revenue and potentially reduce the need for government assistance on some levels.
Another tax reform proposal is the Border Adjustment Tax (BAT). BAT is designed to favor made-in-America products by imposing taxes on imports making them more expensive and less appealing. Because most high-quality dividend paying companies manufacture and provide the majority of their goods and services in the U.S., the impact here would likely be minor.
Imports are already affected by the strong U.S. dollar intrinsically making imports more expensive than locally produced goods. Effectively this already builds in a border adjustment tax to goods manufactured outside the United States. The BAT is theoretically designed to disrupt imports on the larger-ticket items, such as automobiles and machinery, rather than on agricultural commodities or consumer essentials like telecommunication and utility services.
Regulatory and tax reform issues are both in their preliminary stages with the devil hiding in the details. Dividend paying stocks for the long-run based on companies with a solid record of the ability to increase their dividends may provide stability, and predictability to a portfolio. Even investors not focused on income may find advantages with dividend-paying stocks for long-term capital growth by helping long-term investor’s weather market downturns. This is why quality matters, and it’s good to know what you own and why you own it. Stay focused and plan accordingly.
Past performance is no guarantee of future results. Dividends are not guaranteed and are paid at the discretion of the stock-issuing company. This information is general in nature and is not a recommendation of any particular investment. There is no guarantee any particular investment strategy will be successful. Opinions expressed herein are those of the author and subject to change at any time. Consult with the appropriate legal and tax professionals for advice on these matters. “Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNERTM and federally registered CFP (with flame design) in the U.S.”
This article provided by Darcie Guerin, CFP®, Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email email@example.com. Website: www.raymondjames.com/Darcie.