Tax Reform May Provide a Tail Wind for Dividends

Investors love dividends and rightfully so. Dividends increase a stocks total return, reduce risk regardless of investment style and provide a source of income. Dividend payouts also serve as a proxy for the overall health of the economy. Because the economy has been in growth mode, all-be-it slow, dividend payments have been solid. And there is more upside for dividends. Tax reform may provide a tail wind for dividends going forward.

2017 will go down as the sixth consecutive year of record dividend payments for companies in the S&P 500. In the third quarter of 2017, S&P 500 aggregate dividend payouts increased by $15.5 billion (+6.9%) compared with the same quarter last year. Dividend payout reductions were down 85.1% to $500 million from the third quarter 2016. This trend of dividend growth is fueled by rising corporate profits which increase cash flow.

tax reformThere’s reason to believe that 2018 will be another great year for dividends. That’s because proposed tax reform could generate even more cash for corporations due to the proposed reduction of the corporate tax rate from 35% to 20%. There’s also another enticing factor – the billions of untaxed dollars (income) sitting in offshore accounts. Tax reform provisions may make it more palatable for companies to bring that revenue home which would boost cash flow even more.

Companies have several options for putting that cash to use: investing in operations, increasing workers’ salaries, acquisitions, share buybacks and increasing dividend payments. Out of those options, I expect companies to prioritize increasing dividends at least in the near term. Here’s why. First, I don’t see most companies immediately investing to increase operations (capacity) because I think that there will be a lag until demand increases. That’s because consumers may prioritize paying down debt and increasing savings before increasing consumption. Second, I see tax reform as favoring supply side economics. By that I mean that most tax relief will accrue to corporations instead of individuals especially in the short term. So it will take time for demand, which drives expansion of operations, to catch up. Third, acquisitions take time to work through compared with the ability of a corporation to declare a dividend.

When it comes to investing in dividend paying stocks, investors have many options and strategies at their disposal. One easy, low cost and risk averse way to invest in dividends is through Exchange Traded Funds (ETFs). Here’s how three popular dividend ETFs have performed year-to-date ( YTD 2017).

VIG – Vanguard Dividend Appreciation. YTD VIG’s total return is 20.5% and yields 1.93%. VIG tracks the performance of the NASDAQ US Dividend Achievers Index which includes companies that have a record of increasing dividends over time.

VYM – Vanguard High Dividend Yield. YTD VYM’s total return is 14.7% and yields 2.85%. VYM tracks the performance of the FTSE High Dividend Yield Index which consists of stocks that pay higher dividends on average.

SCHD – Schwab US Dividend Equity. YTD total return is 18.5% with a yield of 2.77%. This ETF tracks an index of US high dividend yielding stocks that have a record of consistently paying dividends and for fundamental strength relative to their peers.

So there you have it. My take on tax reform and what it may mean for dividends.

Please note that this is informational only and just my opinion. It is not be interpreted as advice or a recommendation. It is your responsibility to make your own investment decisions in conjunction with your financial advisor.

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