For income-focused investors, the question of intelligent diversification becomes which sector style would you prefer to own? The defensives – which include healthcare, utilities and consumer staples – are the tortoise. The cyclicals – materials, consumer discretionary, financials and real estate – are the hare. And lastly, the sensitives – telecommunications, energy, industrials and technology – are somewhere in between.
Dividends Among Cyclicals and Sensitives
Digging a layer deeper, we find payout growth is very segmented. For example, the sensitives super-sector is dominated by growth in technology dividends, which have expanded rapidly from very low levels.
Going forward, it is worthwhile asking whether technology can be expected to continue growing at rapid rates. If it can, this higher payout growth should be reflected in valuation calculations. One issue we face is that the growth rate for dividends appears to be slowing across all sectors. We can see that technology is still the fastest growing sector in terms of dividend growth, however the dividend advantage is seemingly dissipating when looked at on a five-year rolling basis.
Looking across the other sectors, we see a similar trend. Energy dividends have suffered enormously in recent years, whilst healthcare and consumer staples remain quite stable.
Somewhat worrying for telecommunications is a negative dividend growth rate over the past five years. This is below what would be considered ‘normal’ and would need to revert higher if the telecommunication undervaluation is to normalise.
Which is the better buy? The tortoise, the hare or yesterday’s winner?
On face value, the predicament is to decide whether it is better to buy technology stocks for their historical payout growth record or a sector that offers a contrarian bent.
The answer is not simple. An investor needs to balance an array of return drivers beyond dividend growth. For example, the starting dividend yields are much lower in technology companies. Hence, even if technology grows at a marginally faster pace than utilities over the next 10 years, this may not represent a buying opportunity given overvaluation concerns and a low starting yield.
We also need to acknowledge dividend sustainability and the capital cycle when considering payout growth. Ideally, this should be done on a sector-by-sector and country-by-country basis. For example, our calculations of ‘fair value’ reflect a slightly higher payout growth rate for technology stocks than they do for utilities. They also reflect a slightly higher payout rate in the U.S. than they do in Europe, as a country with structurally high exposure to technology companies. This leads us to favour sectors such as energy, financials and telecommunications as well as countries such as Russia, Italy and selected emerging markets.
