A Dividend Investing Strategy Makes Sense Now. Here Are More Than 20 Picks.

Rates matter for bond prices, which move inversely to interest rates, as well as for stocks, which are valued based on earnings potential compared with a risk-free Treasury rate. Many pros believe stocks are overvalued and getting more so as rates rise.

Taking this into account, a smart strategy for investors with fresh cash to put to work is to buy dividend stocks. They tend to represent good stock values, and several sectors provide plenty of income while offering equity upside.

For more money moves tied to today’s “higher for longer” interest-rate environment, see our stories on finding a safe withdrawal rate in retirement and whether to buy a home while rates are elevated.

Investors often look to the bond market for income, but dividend yields of 3% to 6% are available on a range of stocks in the U.S. and overseas. That’s comparable to bond yields, with most municipal bonds yielding 3.5% or less, Treasuries at about 4%, and high-grade corporate bonds at around 5%.

Don’t Shy From Stocks

There’s nothing wrong with bonds, but stocks offer dividend growth and tax advantages. Most U.S. corporate dividends are taxed at a top rate of 23.8%—including a Medicare surcharge of 3.8%. Investors face a higher tax bite for most bond income, except for munis.

Many investors think they have missed the stock market rally, with the S&P 500 index recently hitting new highs. But the market advance was largely concentrated in the tech sector in 2023, including the Magnificent Seven—

Apple
,

Microsoft
,

Alphabet
,

Amazon.com
,

Nvidia
,

Meta Platforms

and

Tesla
.

That trend has continued into 2024, with shares of Microsoft, Meta, Nvidia, and Alphabet recently hitting record-high prices.

In contrast, most dividend-rich sectors of the stock market have largely sat out the big rally of the past year, including electric utilities, real estate investment trusts, consumer staples, healthcare, banks, and energy. Banks, energy, and utilities, for instance, are actually in the red over the past 12 months.

Plus, the prospect of rate cuts by the Fed this year—even if not as many as investors hoped for a month ago—looks bullish for dividend-paying stocks. Money-market funds, Treasury bills, and certificates of deposit will offer less competition for stocks if short-term rates fall toward 4% by the end of 2024 from the current 5.35%. That could drive individual investors out of money-market funds, T-bills, and CDs, where they have trillions of dollars parked.

One risk is that a continued strong economy prompts the Fed to move even more cautiously than the markets now anticipate. That could dampen demand for dividend payers, but the negative impact on bonds could be more severe.

Look Abroad

There is also plenty of yield outside the U.S., where companies favor dividends over stock buybacks. The broad

iShares Core MSCI EAFE

ETF, which tracks developed markets outside the U.S., yields about 3%, double the dividend rate on the S&P 500.

Overseas stocks have been lagging behind the S&P 500 for a decade, and the same is true this year. International stocks may have their day—although many pros have wrongly called for such a turn for years. It may take a cooling in the U.S. technology sector for that to happen.

Big U.S. tech stocks dominate the S&P 500 and have driven its gains in the past five years. Tech and related companies account for over 30% of the S&P 500 versus less than 10% for broad international indexes. There are few megacap tech companies outside the U.S. The only tech stocks among the top 20 holdings of the

iShares Core MSCI EAFE ETF

are

ASML

and

SAP
.

Thus, buying foreign stocks amounts to a bet that value-oriented stocks will return to favor.

Broad emerging market equity ETFs like

iShares Core MSCI Emerging Markets

have done even worse than developed-market ETFs. The emerging market indexes are little changed over the past decade, hurt by weakness in China—the largest component at about 30%. One positive: Emerging markets have rarely been so inexpensive relative to the S&P 500 index.

For U.S investors who want to stay closer to home and like a diversified approach, there are many U.S. income-oriented equity mutual funds and ETFs yielding around 4%, including

Vanguard High Dividend Yield

and

Schwab US Dividend Equity.

Their portfolios, totaling over $50 billion each, differ somewhat but include a cross-section of big dividend payers such as

JPMorgan Chase
,

Broadcom
,

and

Chevron
.

Stock Selection

For investors who prefer picking stocks, consider which sectors are most attractive and drill down from there.

For example, electric utility stocks offer a good combination of yield, growth, and safety. The industry’s earnings outlook is the best it has been in decades as companies build renewable power—wind and solar—as well as associated transmission lines to decarbonize and fortify the grid. And the growth in electric vehicles should help boost what has been negligible demand growth.

Jay Rhame, CEO of Reaves Asset Management, which runs the

Reaves Utility Income

fund, notes the sector is cheap versus the S&P 500, with the average electric company trading for around 15 times projected 2024 earnings, against about 20 for the index.

Utility stocks yield 4% on average. Earnings and dividends could grow at a mid- to high-single digit annual rate for the rest of the decade, producing double-digit total returns. Utility plays include the

Utilities Select Sector SPDR

ETF or individual stocks like

Duke Energy
,

American Electric Power
,

and

Xcel Energy
.

Another source of yield is energy stocks, which have lagged behind the market in recent months as oil prices have retreated 15% to around $75 a barrel. Industry leader

Exxon Mobil

yields close to 4%, while Chevron yields 4.5% based on its dividend boost in January. Both stocks trade close to their 52-week lows. Their payouts look secure, and both trade for about 11 times projected 2024 earnings.

Even cheaper are European oil companies like

Shell

and

BP
.

Barron’s recently highlighted BP’s allure, including a 5% dividend yield; a low valuation, at seven times projected 2024 earnings; and a new, shareholder-oriented CEO. BP could attract an activist who would push for a breakup of the company, whose parts could be worth double the current stock price.

Energy pipelines have long been a good source of yield, and the industry’s prospects are brightening as capital spending wanes, resulting in greater free cash flow. The growth in U.S. natural-gas production is bolstering the outlook. One risk is lower gasoline demand if electric vehicles gain more market share.

Pipeline companies are structured two ways—partnerships and corporations. The partnerships tend to yield more, including

Enterprise Products Partners

and

Energy Transfer
,

which have distribution yields—the partnership equivalent of dividends—of 7% and 9%, respectively.

“The companies continue to trade at high free-cash-flow yields, with 5% dividend growth, and most are buying back shares,” says Greg Reid, head of energy investments at Westwood Group Holdings, which runs the

Westwood Salient MLP & Energy Infrastructure

fund.

Kinder Morgan

and Williams Companies are two of the leading corporations (as in, they aren’t partnerships) and yield in the 5% to 7% range. Individual investors tend to prefer getting the 1099 tax forms corporations send rather than the K-1s provided by partnerships, and institutional investors can more easily buy corporations. This results in more demand for pipeline companies structured as corporations.

Financial Stocks

Big banks generally yield in the 3% to 4% range, and there are several worth considering now.

Morgan Stanley
,

whose shares have lagged behind those of several of its big peers in the past year, yields 4% and benefits from a large and steady wealth management business.

Citigroup
,

also yielding 4%, is a turnaround story under CEO Jane Fraser and trades cheaply, at nine times projected 2024 earnings. Citi is a favorite of

Wells Fargo

banking analyst Mike Mayo, who thinks the company’s earnings could double by 2026 and that the stock could hit $100, nearly double the current price. He sees a “margin of safety,” with the stock trading for a fraction of its tangible book value—a conservative measure of shareholder equity.

Consumer Names

Investors have justifiably favored so-called internet staples such as Alphabet and Amazon.com in the past five years, but there is something to be said for leading consumer-staples stocks including

PepsiCo
,

Coca-Cola
,

and

Procter & Gamble
,

which have badly lagged behind the market this year.

PepsiCo and Coke yield 3% and trade for about 21 times 2024 earnings. Pepsi sees high-single digit earnings growth this year, and Coke could do the same. Pepsi is dominated by its industry-leading Frito-Lay snack business, while Coke remains the global beverage leader.

The Ozempic effect has weighed on Pepsi and Coke, as investors fear that greater use of the new diet drugs from Eli Lilly and Novo Nordisk could dampen demand for snacks and sugary sodas. That risk seems overdone, given that the number of Americans taking the drugs could total a few million within a year—a small slice of the U.S. population of over 330 million.

REIT Bargains

Real estate investment trusts are one of the more rate-sensitive sectors of the stock market. The sector cratered in 2022 but gained about 10% in 2023, helped by the late-year rally in the bond market. The big

Vanguard Real Estate

ETF yields about 4%.

Sector performance has varied significantly in recent years as apartments and warehouses have bested malls and office buildings by a wide margin. But the laggards have been strong in recent months as investors bet that the worst could be over and the stocks seem cheap.

Simon Property Group

and

Boston Properties

are leaders in malls and offices, respectively.

AvalonBay Communities

and

Mid-America Apartment Communities

are big apartment REITs, while

Prologis

is the biggest warehouse REIT.

Piper Sandler analyst Alexander Goldfarb says one bullish factor is the limited supply of new real estate beyond a current building boom concentrated in Sunbelt apartments and warehouses. He’s a fan of old-style strip malls, which have proven durable in the face of the e-commerce boom.

Brixmor Property Group

and

Kite Realty Group Trust

are two of the larger strip-mall operators.

A Word on Cash

Of course, a portfolio shouldn’t be all stocks, and you’ll want some bonds for diversification in case the economy takes a turn for the worse. But don’t shun cash, the ultimate safe investment. Short rates may be headed toward 3% over the next few years, but even if that happens, cash isn’t a bad asset class.

Holding cash provides sleep-at-night comfort for otherwise equity-heavy portfolios. Plus, it enables investors to quickly take advantage of opportunities that arise in stocks.

Write to Andrew Bary at andrew.bary@barrons.com