With interest rates rising, stocks that pay dividends have fallen. That is due to investors selling shares of traditional dividend-paying stocks such as utilities and real estate investment trusts to buy bonds that pay higher rates of interest. For investors, that results in those stocks being appealing for the long-term due to the lower price, which also results in a high dividend yield.
When the price of a stock falls, the yield of the dividend rises. If the stock is selling for $20 per share and pays a $1 dividend, the yield is 5%. Should the stock fall to $10, the yield becomes 10%. So if the price of a stock falls for reasons other than those having to do with its fundamental business operations or outlook, for long-term investors it is a buying opportunity. Not only is the share price lower, the dividend yield is higher.
That is what is happening with many publicly-traded companies in the utilities and real estate investment trust sector.
Rising Utility Stock Dividends
Utilities have long been called “widow and orphan” stocks due to the predictable yield and robust nature of the business. While the average dividend for a member of the Standard & Poor’s 500 Index is around 2%, there are many solid utilities that pay more than twice that rate. As just one example, Duke Energy (NYSE: DUK) pays a dividend of 4.67%. Pepco Holdings (NYSE: POM) has a dividend yield of 5.67%, as another example.
While utility firms have a tradition of paying dividends, for real estate investment trusts it is required by law.
REIT Dividends Look Enticing
To receive the preferential tax treatment of being a real estate investment trust, 90% of income must be paid out as a dividend to shareholders. There are as many types of real estate investment trusts as there are types of real estate. Some even have to do with the financing, such as mortgages.
The dividend yields from a real estate investment trust can be huge. PennyMac Mortgage Investment Trust (NYSE: PMT), a mortgage real estate investment trust, has a dividend yield of over 10%. For American Capital Agency Corp. (NASD: AGNC), real estate investment trust operating in the residential market, the dividend yield is more than 14%.
Don’t Take the Dividend Yield at Face Value
Many times dividend yields that high can be a warning signal to investors.
The share price has fallen due to problems with the company or industry, which is known as a “dividend trap.” That is what makes utilities, real estate investment trusts, and other stocks that have declined to rising interest rates even more appealing: the business is doing well, it is just the investment climate that does not favor those equity classes.
The role of dividends in the total return of a stock should never be underestimated.
Legendary investor Jack Bogle, founder of the Vanguard mutual fund group, stated in his book Enough that dividend income had provided more than 40% of the historic total return for equity. If an investor is patient and buys a dividend-paying stock after it has fallen, the yield can work out to be an even bigger part of the total return.
As with all stocks, investors must perform the needed research to determine that the long-term prospects of the company are bullish. For the utility companies and real estate investment trusts that prove to be promising, investors should be able to book a healthy total return for the long-term.
Are you looking for dividend stock bargains as interest rates rise?
Jonathan Yates is a financial writer with degrees from Harvard, Johns Hopkins and Georgetown University Law Center. While much of his career was spent working for Members of Congress on Capitol Hill, he was also General Counsel for a publicly traded corporation; and worked in the research department of a brokerage house.
Matt Becker says
I’m sticking with my total market approach, which will include but does not focus on dividend stocks. It does bother me though when people talk about a “flat decade” when they look at the price of the S&P 500, completely ignoring the fact that it was also paying dividends the entire time. You absolutely need to understand the entire picture.
krantcents says
I am still interested in growth in my portfolio and willing to give up immediate income to achieve it.
moneystepper says
Great post and an extremely important point regarding the “dividend trap”. I know many people who have been fooled by this in the past!
Marissa@Financetriggers says
great topic. I’m sure those who are into diversifying their portfolio will find this very useful indeed. definitely worth sharing.