Tough times for income investors: Even with payouts at a record, dividend yields are measly

After a disastrous 2020, when many corporations were forced to cut dividends, these payments to shareholders have been rising for the last several quarters. The dollar value of dividends paid on the S&P 500 will likely hit historic record levels in the third quarter and for the full year, as well. 

“Dividends are back,” Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, told me.

S&P 500: Yearly dividend payouts

• 2017   $420 billion
• 2018   $456 billion
• 2019   $485 billion
• 2020   $483 billion
• 2021 to date:  $522 billion, up 8.1%
  Source: S&P Dow Jones Indices 

Nearly 300 companies in the S&P 500 have raised their dividend this year. 

Overall, dividends in the second quarter were up 4% from a year ago, and 6.5% higher than the pandemic low set in the third quarter of 2020, according to BMO Capital Markets.

“Elevated cash levels, below average payout ratios… and an unprecedented recovery in corporate earnings are setting the stage for an extended rebound in shareholder distribution, in our view, which should ultimately be a positive for U.S. stock market performance as we look ahead to 2022,” Brian Belski, BMO’s chief investment strategist, said in a note to clients.

In particular, energy companies have been either assuring investors the dividend is safe (ExxonMobil) or hiking the dividend after many slashed these payments in the past several years. In the past month, Viper Energy, Devon Energy, Chesapeake Energy, DTE Energy, Marathon Oil, Oasis Petroleum, and Diamondback Energy have all hiked their dividends. 

Other companies that have recently raised their dividend include Estee Lauder, Simon Property Group, U.S. Steel, and Voya Financial.

The reason corporate America is making record dividend payments is simple: Cash flows have been getting stronger as the recovery has proceeded, so corporations are able to divert more money to buybacks and dividends.

Dividends and buybacks both come out of cash flow. Here is how corporate America spent its cash flow in the second quarter:

Cash flow, second quarter

• Dividends: 21%
• Buybacks:   33.8%   
• Capital expenditures:   27.8% 
• Retained earnings, paying down debt:   18%
  Source: S&P Dow Jones Indices

While the dollar value of dividends has risen this year, dividends as a percentage of cash flow has decreased slightly in recent years.

“Dividends have indeed gone up because cash flows have increased,” Silverblatt said.

“However, you are not getting a bigger piece of the pie, because money is being spent in other areas,” he said. ”Over the last several years, corporations have been spending more on buybacks than dividends, and also less on capital expenditures.”

Why the emphasis on buybacks over dividends? “Buybacks are easier to control,” Silverblatt said. “You can stop or increase a buyback. Dividends and capital expenditures are long-term and difficult to reverse.”

The bad news: Because of the relentless rise in the S&P this year (up about 24% year-to-date), dividend yields, at 1.3%, are near historic lows. 

The last time yields were this low was September 2000, when they hit 1.14%.

The long-term average (since 1936) is 3.54%. 

That is a bit strange: Corporate America is paying out more money than ever in dividends, but dividend yields are near a record low.

That may be why investors are not throwing money into dividend-yielding stocks this year.

For example, there have seen modest inflows in the past several months into exchange-traded funds that pay higher dividends, such as the Vanguard High Dividend Yield Index, the ProShares S&P 500 Dividend Aristocrats ETF, and the WisdomTree Quality Dividend Growth Fund. However, this pales in comparison to the huge inflows into plain-vanilla index funds like those that are tied to the S&P 500 (say, the SPDR S&P 500 ETF or the iShares Core S&P 500 ETF) or to the Russell 2000 (iShares Russell 2000 ETF), or the Nasdaq 100 (the Invesco QQQ ETF).

“Investors are choosing more targeted value-oriented ETFs, or they’re choosing more broadly diversified ETFs, rather than owning companies that have historically increased dividends,” Todd Rosenbluth, director of ETF and mutual fund research at CFRA Research, told me. 

He explained there were two problems. “The stocks with attractive yields are in more defensive sectors like Utilities and Consumer Staples, and investors are favoring growth over those defensive sectors. Second, yields are low,” which makes dividend investing unattractive for many.

Silverblatt concurred. “If earnings continue to rise, you should continue to see dividends rise,” he told me. 

“However, it’s hard to live on dividends because those yields are so low,” he added.

There is hope, Belski says that those yields will start to rise as cash flow continues to improve into 2022. “Even with dividend payments for the S&P 500 already on pace for a record-setting year, we believe there is further room for growth in the coming periods,” he said.