By Lawrence C. Strauss

Stocks with a history of steady and consistent dividend increases can help buffer investor portfolios amid all of the recent stock market volatility and uncertainty around tariffs and interest rates.

"It makes a lot of sense to be going into other types of fundamental strategies," including dividend growth, says Brian Belski, chief investment strategist at BMO Capital Markets.

In a research note, Belski wrote that dividend growth stocks worked "during periods of trepidation."

He expects the market to broaden out this year beyond the small number of large-cap technology stocks, most notably the Magnificent Seven, that have dominated in recent years.

The S&P 500 Dividend Aristocrats, a proxy for large-cap dividend growers, returned about 4% this year through March 3, including dividends. That's better than the slightly negative result for the S&P 500 index, which has been volatile after initially rallying following the presidential election in November.

The market's biggest worries include the impact of tariffs being levied by the Trump administration, a softening of consumer confidence, and signs that inflation isn't abating enough.

The Aristocrats, which include Walmart and Emerson Electric, have paid out a higher dividend for at least 25 straight years, a testament to solid underlying fundamentals in all sorts of economic conditions. One way to get exposure to those companies is the $12 billion ProShares S&P 500 Dividend Aristocrats exchange-traded fund (ticker: NOBL).

Still, dividend growers can have periods of underperformance, especially in up markets. Last year, for example, the Aristocrats returned 7%, compared with 25% for the S&P 500. In 2022, though, when both stocks and bonds sold off sharply, the Aristocrats fell by 6%, handily outperforming the S&P 500's minus 18% result.

Peter Fisher, manager of the $50.4 billion Vanguard Dividend Growth fund (VDIGX), looks for "companies that can steadily compound their dividends over time." The payoff, he adds, is that "companies that can sustainably grow their dividends are going to be good long-term performers."

Fisher says he doesn't buy stocks "with any sort of macro view" but looks to scoop up reliable dividend growers when their prices are cheaper.

One of the fund's holdings is retailer TJX Cos., which yields 1.2%. The company has put through regular dividend increases, most recently to 37.5 cents on a quarterly basis -- or $1.50 a share annually. That was an increase of nearly 13%.

While many retailers have to predict what their customers will want to buy, TJX sells discount merchandise that other companies need to unload. "They really are able to manage their profitability, and it has been a fantastic model," he says. "It grows because they're delivering really, really good value to their customers." The stock has a one-year return of about 26%.

Other top holdings in the fund as of Dec. 31 included McDonald's, which yields 2.3%; Stryker, 0.9%; and Danaher, 0.6%. As those latter two stocks show, dividend investing can involve a trade-off between higher yields with slower growth and faster-growing dividends with lower yields.

Case in point: Microsoft, another of the fund's holdings. While the tech stalwart yields 0.9%, the dividend has been regularly increased at around a 10% annual clip in recent years.

Belski says that a good starting point for finding attractive dividend growth stocks is looking for those whose free-cash-flow yield is bigger than its dividend yield. "If you've got the cash, that means you can continue to pay the dividend," he says.

Belski and his team recently ran a stock screen looking for sound dividend growth companies. Besides having a cash-flow yield that exceeded the dividend yield, other criteria included no dividend cuts in the past five years, a one-year dividend-per-share growth rate higher than the S&P 500's, and a current dividend yield higher than that of the S&P 500.

He also sought companies whose dividend payout ratio -- the percentage of earnings paid out in dividends -- was below the S&P 500's level.

Stocks meeting those criteria have had a 16.5% compound annual return since 1990, compared with just under 11% for the S&P 500, according to BMO's investment strategy group.

Stocks meeting that screen's criteria include freight railway operator CSX, which yields 1.6%; Caterpillar, 1.7%; Marathon Petroleum, 2.5%; and Tractor Supply, 1.7%. (See the accompanying table for more details on these stocks and others.)

Another consideration for investors is that the S&P 500 is coming off back-to-back calendar year returns in excess of 20%, a rare occurrence that hadn't happened since the 1990s.

"The market typically and historically does have more swings that third year," says Belski. If capital appreciation is more muted this year, dividends should help support those returns.

Where interest rates end up this year is another factor that can weigh on stocks. Higher rates pose competition for stock yields. The Federal Reserve has paused cutting short-term rates, at least for now, as concerns flare about inflation rising.

The 10-year U.S. Treasury note's yield has bounced around, falling to around 4.2% recently -- down from around 4.8% in mid-January.

Lower yields on the 10-year Treasury should benefit dividend stocks, in part because the competition isn't as strong. Conversely, if bond yields increase, some dividend stocks can withstand that scenario.

During the eight periods going back to 1990 in which 10-year Treasury yields rose for a year or longer, the stocks that met the criteria in BMO's dividend growth strategy outperformed the market by 5.4 percentage points on average.

"This is not a momentum trade," says Belski, of dividend growth names. "This is more of a bottom-up, fundamental strategy."

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March 07, 2025 21:30 ET (02:30 GMT)

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