For Dividend Growth, Consider Health-Care and Tech Stocks - Barron's

For Dividend Growth, Consider Health-Care and Tech Stocks - Barron's

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Traditional dividend havens such as utilities and real estate investment trusts are expected to continue that role, with yields in the 3% range this year. Those looking for more robust dividend growth should consider sectors such as health care and technology.

The health and tech sectors in the S&P 500 index are expected to notch the best dividend growth this year on a per share basis, 10% for health care and 9% for tech, according to consensus estimates. Those two sectors are expected to increase their earnings this year by roughly 10%, compared with mid-single digits for utilities and REITs.

IHS Markit, a financial-data firm, expects U.S. dividends paid out to total a record $663 billion this year, up 7.2% from 2019’s levels—but below the 7.9% gain the previous year. That 2020 estimate, which excludes special dividends, covers the entire U.S. stock market, including the S&P 500.

Divining Dividend Growth

Health-care firms are expected to have the largest dividend increases this year.

These are consensus estimates. *Estimated growth compared to previous year.

Sources: Bloomberg, FactSet,Goldman Sachs Global Investment Research

The slower dividend growth “is mainly attributed to a slowdown in earnings growth when compared with 2018 earnings growth, which was boosted by tax cuts,” IHS Markit says in its 2020 forecast.

Still, there should be plenty of dividend growth this year across various sectors, starting with health care. Dividends usually grow in line with earnings, and the health-care sector, from large pharmaceutical firms to a major prescription-drug distributor, offers plenty of strength. “The amount of money spent on prescription drugs has nearly doubled over the past three decades as pharmaceuticals sales and profit margins have ballooned,” the forecast says.

The consensus earnings estimate for the Health Care Select Sector SPDR (ticker: XLV), a good proxy for larger health-care companies, is $6.31 a share, up 8% from $5.82 in 2019.

In its recent assessment of dividend trends, IHS Markit noted that the health-care sector “has shown a very aggressive capital deployment stance in [fiscal-year 2019] with mergers and acquisitions being the top priority followed by rising cash dividends.”

IHS Markit expects the sector to boost its dividends by 9.3%, helped by sustainable free cash flow and lower debt levels.

Goldman Sachs shares IHS Markit’s optimistic outlook for health-care dividend stocks. For analytical purposes, Goldman divides the broad market into various baskets of stocks, one of which focuses on dividend growth. That particular basket, Goldman Sachs wrote in a note dated Jan. 3, “offers longer-term investors a premium yield while positioning for a value rotation.”

Growth stocks have underperformed value names for many years, though growth stocks did better in the last four months of 2019. Goldman Sachs observed in the research note that “the outlook for growth and value remains muddy” as stand-alone investments, and that “we recommend strategies that combine growth and value.”

Goldman’s dividend-growth basket of stocks was recently yielding 3.6%, compared with 2.1% for the S&P 500, and it traded at a substantial discount to the broader market. These stocks offer 10% dividend growth through next year, compared with 5% for the broader market, Goldman Sachs says.

The health-care stocks in the basket are AbbVie (ABBV), which recently yielded 5.3%; Gilead Sciences (GILD), 3.9%; Pfizer (PFE), 3.9%; Cardinal Health (CAH), 3.9%; Amgen (AMGN), 2.7%, Bristol-Myers Squibb (BMY), 2.8%; and Eli Lilly (LLY), 2.2%.

Meanwhile, the tech companies in the S&P 500 are expected to increase their dividends by an average of 9% on a per share basis, based on consensus estimates.

IHS Markit notes that “many of the leading tech payers have relatively large cash balances and low debt profiles, reinforcing the sector’s status as top payer.” That includes Microsoft (MSFT), which has regularly increased its dividend at a double-digit pace, and Apple (AAPL), whose net cash at the end of September totaled $98 billion. Microsoft was recently yielding 1.3%, and Apple was at 1%—both well below the S&P 500’s average of about 2%.

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The yields of Microsoft and Apple are also punier than the tech stocks in the Goldman Sachs dividend-growth basket. But in terms of total dividend payouts expected this year, Microsoft and Apple are expected to rank in the top five of U.S. companies, according to IHS Markit.

The tech names in Goldman’s dividend-growth basket include Texas Instruments (TXN), which recently yielded 2.8%; IBM (IBM), 4.8%; Broadcom (AVGO), 4.2%; Cisco Systems (CSCO), 3%; and NetApp (NTAP), 3.1%.

Of course, health care and tech aren’t the only sectors that offer dividend growth. Based on consensus estimates, consumer-discretionary and energy companies in the S&P 500 are expected to boost their dividends this year by 8% on average.

Consider, though, that the Consumer Discretionary Select SPDR exchange-traded fund (XLY), a proxy for companies in that sector, yields about 1.3%—not all that enticing. And energy stocks have lagged behind the broader market, their attractive yields notwithstanding. The Energy Select Sector SPDR ETF (XLE) was recently yielding about 3.7%.

Utilities in the S&P 500 are expected to boost their dividends on a per share basis by an average of 7%, a respectable gain if it occurs. However, many of these stocks have been bid up, as investors seek yield in a low-rate environment, essentially treating them as a bond proxy.

The Utilities Select Sector SPDR ETF (XLU), for example, trades at about 19.7 forward earnings estimates, some 15% above its five-year average of 17.2 times, according to FactSet.

Income investors could also turn to the financial, materials, and industrial sectors of the S&P 500 for yield growth. Such stocks are expected to boost their dividends by 6% this year on a per share basis, according to consensus estimates.

Take financials, for instance. They are expected to yield 2.2% on average, and many individual banks sport even higher yields. JPMorgan Chase’s (JPM) was recently at 2.6%, the same as Citigroup’s (C). Wells Fargo (WFC) was at 3.8%, compared with a 2.1% yield for Bank of America (BAC).

Although dividend growth should slow this year, there should still be plenty of yield available in various sectors. But it’s important to understand the fundamentals of a company, even if its yield is alluring. 

Write to Lawrence C. Strauss at lawrence.strauss@barrons.com

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2020-01-09 11:45:00Z
https://www.barrons.com/articles/for-dividend-growth-consider-health-care-and-tech-stocks-51578570301
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