The reason investors love dividend ETFs is simple…
Since dividend-paying stocks have a history of outperforming other equities during market downturns, many investors assume that dividend ETFs will provide an even greater margin of safety.
But one look at the following chart should dispel the “safe harbor” myth about these investments.
The chart tracks the performance of three equity income ETFs compared to the SPDR S&P 500 Trust ETF (SPY) during the height of the financial crisis in 2008 and 2009.
From December 31, 2007 to March 9, 2009, the SPY declined 53.4% – representing one of the largest corrections in history.
As you can see, dividend-paying stocks didn’t do much better than the broader market…
This isn’t a one-off event, either. Similar results were recorded during the decline from July to October 2011.
Indeed, dividend ETFs are not built for defense. They’re simply tools best used for income and capital appreciation when bullish periods warrant their application.
A better investing alternative is to find value-priced dividend stocks with a consistent history of increasing dividends. This has the added benefit of limiting drawdowns in higher volatility.
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McDonald’s saw a decline of just 9.95% during the financial crisis, while Wal-Mart actually saw a small gain of 1.3% during that time.
Now, before you take action, understand that MCD and WMT aren’t as healthy today…
MCD sits near its 52-week low, due in part to a 7% decline in July same-store sales in Asia, as well as a 3% drop in the United States. This poses a huge threat to the stock. And Wal-Mart continues to see stagnant sales and dwindling traffic patterns, as evidenced by its fifth consecutive quarter of negative U.S. sales and its sixth straight quarter of falling traffic.
So it’s unlikely that either will outperform in a future correction.
But that doesn’t mean investors don’t have alternatives…
Below are three stocks – each with a market cap of at least $500 million – that not only held up well during the financial crisis, but also boast attractive valuation levels.
These companies sport attractive price-to-book ratios and golden ratios well below the median S&P 500 constituents.
In the second quarter of 2014, 1st Source experienced an increase in loan growth of $145.97 million more than in Q1 2014. These spectacular results were more than $230 million more than their results from Q2 2013. And the company is showing no signs of slowing down.
Tompkins is well-capitalized with strong performance. Since 2005, the company has maintained annualized deposit and loan growth rates of 11% and 12%, respectively. With its entry into Pennsylvania, this growth rate should continue.
Community Trust Bank maintains solid financials, with a low free cash flow payout of 28% and a reasonable debt to total capital of 41%. CTBI announced its intention to increase its dividend by 3.4% effective October 1. This marks the company’s 34th consecutive annual dividend increase.
Bottom line: If the markets correct, as many expect, taking cover in dividend ETFs could destroy your portfolio. By using a better strategy of buying stocks with long histories of raising dividends – in combination with low EV/EBITDA ratios – investors can mitigate exposure to market corrections.
Safe (and high-yield) investing,