5 Answers to Equity Income FAQs
I often get questions from clients about equity income and whether investing in dividend-paying stocks is a strategy they should consider. The dividend element of stocks is often overlooked, but I think it’s an important part of a successful strategy.
Here are my answers to five of the most common questions I hear.
1. How does an equity income portfolio differ from other stock portfolios?
Equity income is very different from many other ways of generating money through stock ownership. With equity income, you’re looking to earn money from the dividends instead of solely growth in stock price. Stocks are traded less frequently—they can be held anywhere from 3 to 5 years. To make a comparison, Pinnacle’s core equity portfolio is a large-cap strategy that is more growth oriented. Our equity income portfolio is also a large-cap strategy, but it is more focused on earning income through dividends.
2. Who should consider an equity income strategy?
This strategy may make sense for investors with a longer term horizon. They are not recommended for investors who are investing for a year or less. Baby boomers who need cash-generating investments to fund their retirement should consider focusing on stocks that pay dividends, particularly in today’s low interest rate environment. Equity income can offer higher returns compared to bond or money market funds.
3. What kind of stocks are included in an equity income portfolio?
Every portfolio manager has a different style, but what we look for here are domestic, large-cap and well-known stocks. Occasionally we consider mid-size companies and international large caps. We want companies that are profitable and also have a history of paying and growing a dividend. To the best of our ability, we will avoid companies that cut their dividend. The portfolio is fully diversified across all economic sectors from consumer discretionary to technology. We have some energy and utility stocks, but the portfolio will not have large over-weights in these areas.
4. What would make you want to sell a stock?
We hope that all of the stocks in the portfolio do well, but when the price of a dividend stock appreciates faster than the dividend grows, the dividend yield goes down. When that happens, we would sell the appreciated stock and look for ones with a higher dividend yield. We would also look to sell a stock if the company started paying out too much of earnings in dividends. An abnormally high dividend payout ratio is a precursor for a dividend cut. Of course we would also liquidate a stock if there were an increased chance of a dividend cut.
5. What is your outlook for dividend stocks?
As a result of the current low interest rate environment, some of these dividend stocks have had a huge run over the last few years. An increase in interest rates could easily take some steam out of these dividend plays. Lately, we have been focusing on stocks that have not participated in the recent run to protect the downside of the portfolio. One thing that has not changed is the need for income. Dividend stocks typically are less volatile than growth stocks, but like all stocks, they can lose value in the short run.