While investors are concerned that equity growth has gotten ahead of actual earnings, something that could result in a disappointing 2014 if there are some unexpected negative shocks, Citi analyst Tobias Levkovich thinks that investors can benefit from buybacks and dividends because so many companies on the S&P 500 (INDEXSP:.INX) have strong balance sheets and cash on hand.
S&P 500 constituents’ fundings
“Given clean balance sheets and strong cash flow, companies have the ability to spend money on buybacks, dividends and capital. At the present time, there is no pressure for business leaders to make difficult decisions as to how to allocate their cash resources or leverage capability,” writes Levkovich. “In the past few years, the S&P 500 (INDEXSP:.INX) constituents have been able to fund their various uses of cash and very probably can maintain their ability to continue investing across a broad spectrum that can reward shareholders and allow for economic expansion and top-line improvement.”
In the scramble to find underbought stocks it’s easy to forget that earning and reinvesting dividends can be just as effective as a long-term investment strategy as chasing price growth. Even if nothing looks particularly cheap right now, buying a high quality stock that looks like it will pay better than average dividends could be a good way to approach the current market situation. Quality stocks are also more likely to continue growing when tapering puts pressure on companies with weak balance sheets.
Tight PE dispersion
With tight PE dispersion like you find right now, the difference between value stocks and quality is less than it normally would be, so the incentive to invest in companies that appear to be cheap just isn’t that strong if there are other downside risks to take into account. Value investing strategies aren’t always able to identify good deals, and this could just be one of those times when value investors need to sit back or choose another tack temporarily.
For those not used to chasing dividends as their primary investment strategy, Jae Jun from Old School Value has a solid guide to get you started, explaining the basic mechanics behind the dividend payout ratio and pointing out some common pitfalls to look out for.