After experiencing a year of bruising outflows, stock mutual funds have finally begun soaking in new money. Analysts expect that as cautious investors begin wading back into stocks, companies that pay dividends will be particularly attractive.
Last year investors relied heavily on bond funds, which experienced steady inflows throughout 2012. Like bonds, dividend-paying stocks provide investors with a regular stream of current income. At the same time, they also provide more room for growth than other income-generating investments. As such, they serve as a natural transition between the fixed-income and equity markets. And with 10-year treasuries yielding just 1.86 percent, investors seem ready to take the plunge.
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In the week ending January 9, stock funds took in $14.3 billion, according to the Investment Company Institute. Meanwhile, the following week, the number was $9.3 billion. "Perhaps [that] suggests that investors are moving away from the mindset that the only way to earn money is in a bond fund," says Jeff Tjornehoj, the head of Americas research at Lipper.
Todd Rosenbluth, an equity analyst for S&P Capital IQ, is generally optimistic about the prospect for dividends in 2013. However, he cautions that investors need to be selective. "Not all dividend-paying stocks are the same, and not all dividend-paying stocks are attractive," he notes.
In terms of individual companies, Rosenbluth predicts a good year for Johnson & Johnson, Chevron, General Mills, and Microsoft, both in terms of dividend stability and the companies' valuations. By sector, Rosenbluth suggests looking for opportunities in the healthcare space. "We like the healthcare sector," he says. "This is a sector that has a history of consistent dividend-paying stocks." As examples, he lists Johnson & Johnson, Pfizer, and Merck.
By contrast, he cautions against the telecom and utilities sectors. "We think utilities stocks and telecom-services stocks, while some of the highest-yielding sectors, have less room for capital appreciation," he says. "We don't think they're attractive from a full total-return [perspective.]"
Overall, last year was a strong year for dividends. USA Today recently reported that the dividend yield of firms that pay one rose to 2.81 percent at the end of 2012, up 16 percent for the year.
For investors hoping for an equally strong 2013, the main thing to focus on is earnings. Companies with strong earnings flows are in the best position to pay out dividends. "Typically, dividends grow in the same direction as earnings," says Rosenbluth. "If you [predict] earnings growth in 2013 and 2014 in a dividend-paying stock, there's a good chance that the dividend will increase in a similar fashion." By contrast, he notes, "if the expectation is that the company is facing challenges ... then that dividend is more at risk."
The extent to which investors focus on dividends will depend highly on their personal financial situations. Cautious investors, particularly those nearing retirement, may enjoy the peace of mind that the steady income provides. More aggressive investors, by contrast, may prefer to focus more on capital appreciation than on dividends.
In the current market climate, though, caution appears to be the catchword of the day. And as long as that's the case, dividend-paying companies will continue to capture investors' attention.