By Al Root

Dividend stocks are in a tough spot. They should be performing better, amid expectations for more interest-rate cuts, but a strong jobs market and higher Treasury yields are holding them back.

Income-seeking investors can look to some other tested strategies to generate income -- and avoid nasty surprises.

Wolfe Research Chief Investment Strategist Chris Senyek tracks a bevy of dividend strategies. Two popular ones involve owning the Dividend Aristocrats -- companies that have raised dividends for at least 25 consecutive years -- and stocks with the second-highest quintile of dividend yields, instead of ones with the highest payouts. Senyek says the highest yields are typically high for a reason -- and better to avoid them.

Both strategies suffer from interest-rate anxiety. Dividend-paying stocks have underperformed since September, says Fairlead Strategies founder and market technician Katie Stockton, and she doesn't see a turnaround soon. Stockton isn't making a fundamental call on shares. Instead, she's looking at chart patterns to get a sense of how investors feel. They seem nervous.

There are other options for investors. Senyek looks for companies that can start a dividend for the first time and companies that have recently cut their payouts. Initiating a dividend signals that management is confident about achieving a consistent level of earnings and cash flow. It also opens up a new investor base for the stocks.

In 2024, S&P 500 index dividend payers returned roughly 35% of net income and 45% of free cash flow to shareholders, according to Bloomberg. The average yield for payers was about 2.3%; weighted by market capitalization, it was about 1.5%.

Shares of dividend cutters underperform leading up to the cut, perform in line with the market for the first few months after the cut, and then outperform starting at some six months, Senyek says. The trick is to pick companies at risk of a cut while revisiting shares of companies that slashed a payout a few months back.

To predict cuts, he looks for companies with high dividend yields, high debt, and high payout ratios. He has a list of more than 50 stocks. Six that Wall Street analysts don't like right now include Kohl's, Vail Resorts, Wendy's, Huntsman, Kinetik, and Ardagh Metal Packaging.

The six yield an average of about 8%, have paid out far more in dividends than they have earned in the past 12 months, and have an average debt to earnings before interest, taxes, depreciation, and amortization, or Ebitda, of about five times. A ratio of two to three times would be considered relatively safe. Less than 30% of analysts covering those stocks rate them Buy. They look risky.

Two companies that already cut payouts in 2024 that Wall Street likes now are 3M and International Flavors & Fra. 3M reduced its payout in May around the time it spun off its healthcare division, now called Solventum. Flavors & Fragrances cut its payout in February. Almost 75% of analysts covering Flavors & Fragrances rate shares Buy. About 53% of analysts rate 3M stock Buy. With lower payouts, dividends should consume 35% to 40% of projected 2025 net income.

Then there are potential new dividend payers. To find them, Senyek looks for companies with strong free-cash-flow yields that are buying back stock and don't have too much debt. His list runs to more than 70 stocks. Six with strong analyst support are Skechers, Crocs, Regeneron Pharmaceuticals, Robinhood Markets, Mattel, and tech-services company EPAM Systems.

About 70% of analysts covering the stocks rate shares Buy. The six have repurchased about $1.3 billion worth of stock over the past 12 months and generated more than $11 billion in free cash flow. Earnings and free cash flow are expected to continue in 2025 -- and dividends could follow.

Write to Al Root at allen.root@dowjones.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

January 16, 2025 02:00 ET (07:00 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.