Michael Brush

Opinion: Buffett loves cash dividends and here’s why you should too – plus 8 stocks with higher yield to get you started.

Dividend-paying stocks are consistent, defensive and tend to outperform over time

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In this uncertain stock market, one all-weather investing tactic makes especially good sense: own stocks that pay an attractive dividend yield.?

“Dividends pay out all the time. It doesn’t matter what is going on in the broader market,” says Kelley Wright, the managing editor of Investment Quality Trends, a dividend oriented stock letter.?

Dividend stocks?are not just defensive; they play offense too. John Buckingham, editor of the Prudent Speculator stock letter, notes that yield plays outperform even when interest rates are rising. They also outperform with less volatility. “You get the holy grail of higher investing returns with lower risk,” Buckingham says. ?

Dividend stocks also command authority. Dividends account for 37% of the S&P 500’s SPX, +0.56% total return since 1936, according to Bank of America research. That fell to 17% during the past decade when low interest rates favored growth stocks (which normally don’t pay a yield). This dry spell tells us dividends are about to play a bigger role in returns, if mean reversion holds.?

That’s what Cabot Dividend Investor editor Tom Hutchinson believes. He says we are in a phase of sustained higher inflation and interest rates, since historically it has taken years to quell inflation. These conditions favor dividend stocks. During prior sustained periods of high interest rates and inflation in the 1940s and 1970s, dividends contributed 62% and 73% of market return, he says.?

Moreover, dividends tend to grow over time. Companies with solid businesses, backed by sound balance sheets, continually raise their dividends. This serves as a nice inflation hedge. Warren Buffett just brought this concept home in his most recent Berkshire Hathaway BRK.A, +0.07%. BRK.B, +0.18% shareholder letter.?

Buffett wrote that the annual dividend payout on his 400 million shares of Coca-Cola KO, +1.64% was $75 million when he bought the position in 1994. By 2022, that had increased to $704 million. “Growth occurred every year, just as certain as birthdays,” said Buffett. He predicts the Coke dividend will keep growing. That $704 million a year now represents a 54% yield on the original cost of his position, which was $1.3 billion.?

Bank of America analysts also point to four other reasons why dividend stocks are important additions to your portfolio.

First, the S&P 500 dividend payout ratio is near historical lows. This means companies have a lot of room to raise dividends.

Second, Dividend per-share growth has lagged earnings growth by about 40% over the past two years. Dividend hikes normally follow earnings per share (EPS) growth. The recent lag tells us dividend growth is about to accelerate to catch up.?

Third, people are living longer. More people will buy yield stocks to prepare for retirement and old age, and they’ll hold them longer.?

Finally, income funds represent 40% of active management today vs. 10% in 2010. This creates greater demand for yield stocks, and puts a floor underneath them.?

Eight dividend plays to consider?

Here are six stocks dividend experts like, and two favored by corporate insiders.?

1. Morgan Stanley: To find discounted yield stocks, the newsletter Investment Quality Trends favors names that have fallen enough to boost dividend yields near peak levels. (Assuming no dividend cuts, yields rise when stocks fall.) The investment bank and brokerage Morgan Stanley MS, -2.20% fits the bill. Its repetitive high yield is 3.55% and the current 3.15% yield is close enough. The bank’s dividend payout is 45% of earnings which is low. The bank has plenty of headroom to keep hiking its dividend. It has raised the dividend 10% a year on average for the past twelve years.?

2. Lowe’s Cos.: Shares of this home improvement retailer have weakened enough to drive its yield above the 2% where it normally peaks out. Lowe’s LOW, -0.12% also has history of hiking its dividend by 10% on average over the past twelve years. This trend and the relatively low 41% payout ratio suggest Lowe’s has a lot of room to keep the dividend increases going, Investment Quality Trends notes.

3. Bristol Myers Squibb: Buckingham at the Prudent Speculator singles out this pharma giant. Investors appear skeptical of Bristol Myers Squibb s BMY, +1.05% ability to offset pressure from the 2028 loss of patents for Opdivo for cancer and Eliquis for blood clots. But the company has a strong pipeline of potential therapies including Camzyos for cardiomyopathy, Opdualag for melanoma, Zeposia for multiple sclerosis and Sotyktu for psoriasis. The stock trades for less than nine times forward earnings estimates, well below the historic average. Buckingham has a $102 price target.?

4. NetApp: Buckingham also favors this software company which offers cloud and storage services. He says a solid balance sheet supports the dividend, and the NetApp NTAP, -0.76% stock looks cheap relative to its history and peers. It has a forward p/e of 12. Buckingham expects ongoing demand for cloud services to support growth. He has a $96 price target on the shares.

5. ONEOK: Hutchinson at Cabot Dividend Investor likes this midstream energy play which benefits from steady growth in demand for natural gas pipelines. ONEOK’s OKE, +1.43% Earnings per share grew 28% in the fourth quarter and 15% for all of 2022.?

6. NextEra Energy: Hutchinson also suggests this Florida electricity utility which has a renewables business that’s finally turned profitable. NextEra Energy NEE, +2.55% shares have declined even though fourth-quarter 2022 earnings growth was solid. In the weakness, insiders have purchased $1.7 million worth of stock in the $70 to $75.44 range, according to The Washington Service.

Plus: 2 energy stocks that insiders are buying

At my own stock letter, I follow corporate insider buying for leads on stocks to evaluate. Recently there’s been active insider buying at two energy giants with attractive yields. At ConocoPhillips COP, -1.03%, a director bought $1.2 million worth of stock in mid-February at about $104 a share. At Devon Energy DVN, -0.32%, CEO Richard Muncrief bought $798,000 worth of stock at around $53 and a director bought $250,000 worth at about the same price in mid-February.

Avoid covered call ETFs

Videos promoting covered call exchange traded funds (ETFs) have become popular on YouTube. These ETFs own stocks and sell covered calls against them to produce income. Some brandish enticing yields of 12% and more.

Sadly, YouTube channels touting the high yield (one video unfortunately has 1.4 million views) leave out a crucial detail: You can lose a lot of money in covered call ETFs. The reason: Selling covered calls for income works out great until a stock rockets up through your strike price. Then you are obligated to sell someone the stock at a price below market levels, giving up a lot of upside. Since markets generally go up over time, this happens a lot.?

The bottom line: Dividends are valuable in investing. But beware of YouTube and videos and other promotions offering dividend gimmicks as part of their “quick path to early retirement” clickbait.

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned shares of NEE. Brush has suggested MS, LOW, BMY, OKE, NEE and COP in his stock newsletter,?Brush Up on Stocks. Brush writes the Cabot SX Cannabis Advisor. Follow him on Twitter @mbrushstocks.

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