Investors are starved for yield. It’s not exactly breaking news. With traditional savings vehicles such as savings accounts, CDs, and bonds yielding next to nothing, investors have been flocking to dividend-paying stocks for years.
On the surface, this makes all the sense in the world. Unlike fixed income investments, dividend-paying stocks tend to enjoy rising payouts over time (or at least they do if you choose them well).
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There‘s just one problem with this. Defensive, dividend-paying sectors are, as a group, expensive relative to the broader market. Investors are paying a premium for slow growth…which is not exactly a recipe for long-term investment success.
As an example, consider the utilities sector. The Utilities Select Sector SPDR ($XLU), a popular ETF proxy for the sector, trades for 16 times earnings and yields just 3.7%.
Utilities have had good multi-year runs. In the 2003-2007 bull market, utilities were actually one of the best-performing sectors. But it’s hard to get excited about them at current prices.
Surprisingly, some of the best dividend deals on offer are in the tech sector. Microsoft ($MSFT), Intel ($INTC) and Cisco Systems ($CSCO) yield 2.8%, 3.7% and 3.2%, respectively, and all trade at very modest valuations. All have also been aggressively raising their dividend in recent years. Cisco has nearly tripled its dividend in the past year and a half, and Microsoft and Intel have raised their dividends by 15% and 7%, respectively, in the past year. Not bad for boring “old” technology companies.
If you are building an income portfolio, you have a choice. You can load on slow-growth utilities. Or, you can build a portfolio of solid technology companies with dividends not too much lower that offer far great potential for growth in the dividend stream over time. The choice should be obvious.
Action to take: Buy “Big Tech” for dividend growth. Use a stop loss appropriate for your risk tolerance; I recommend something in the ballpark of a 20% trailing stop.
This article first appeared on TraderPlanet.
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