Morgan Stanley
Wealth Management

4 Ways to Play Defense With Dividend Stocks

May 31, 2023

Dividend stocks in industrials, health care, consumer staples and global markets could help your portfolio stay resilient in today’s uncertain environment.

Author
Daniel Skelly
Daniel Skelly

Key Takeaways

  • Amid potentially muted U.S. equity performance, dividend stocks may help boost returns and dampen volatility in a portfolio.
  • Consider actively managed strategies offering exposure to U.S. dividend payers in industrials, health care and consumer staples.
  • International stocks tend to pay higher dividends than their U.S. counterparts and may enhance portfolio diversification. 

The stock market has managed to stay positive for much of this year. However, with interest rates at their highest level in more than a decade and economic growth slowing, not to mention recent turmoil in the banking sector, uncertainty looms large. Additionally, equity valuations are already high relative to earnings—and current earnings estimates may be inflated. As a result, investors may see another drop in the stock market before they can truly declare the bear market over.

 

Against this backdrop, Morgan Stanley’s Global Investment Office suggests that investors remain defensively positioned and seek out opportunities in select dividend stocks, for two key reasons:

 

  • Dividends may play a larger role in generating returns. The next several years are likely to be marked by lower equity returns and higher volatility, which could lead dividends to account for a greater portion of total stock market return. From 2013 through 2022, about 17% of the S&P 500 Index’s total return came from dividends. But over a longer horizon, starting from the 1930s, dividends accounted for 37%. The next several years will likely look more like the longer-term picture.
 
  • Dividend stocks may buffer against market volatility. When a company can reliably pay dividends or even increase them, it likely has a certain level of financial strength and discipline. For investors, this regular income stream can offer some hedge in what continues to be an uncertain stock market. In fact, in 2022, the S&P 500 overall lost about 18%, but the S&P 500 Value Index (which is often used as a proxy for dividend stocks) kept its losses to about 5%, and the S&P 500 High Dividend Index lost about 1%. In the same period, Morgan Stanley’s Dividend Equity model portfolio returned a positive 1.8%.

 

How to Invest in Dividend Stocks Today

There are several areas of opportunity for active stock pickers to integrate dividend stocks within their portfolio.

  1. 1
    Industrials:

    This sector covers a wide range of industries, including manufacturing, distribution, transportation and defense. In particular, we favor defense companies that are likely to benefit from strong cash flows and bipartisan policy support: Mounting geopolitical conflict and aging defense infrastructure spurred Congress to boost defense spending by 10% for 2023, up from an average 3% per year since the 1940s. We expect lawmakers to continue to support increases to the defense budget and believe companies with exposure to high-priority programs, such as aeronautics and space, stand to benefit.

     

    Additionally, select waste-management businesses may also warrant a closer look, particularly large firms with a full range of offerings that may benefit from sustainability-focused investments in areas like recycling and fleet electrification.

  2. 2
    Health Care:

    This sector offers attractive portfolio-diversification benefits, having outperformed the market by an average of 13 percentage points over the last four recessions. At the same time, exposure to innovative trends like genomics and medical AI may make the sector attractive to investors seeking to play both offense and defense. One defensive area to consider is managed-care organizations that have vertically integrated in recent years to help reduce costs and expand profit margins. Notably, investors’ concerns about government intervention in this industry tend to drive valuations lower in the one to two years leading up to a U.S. presidential election, even as earnings remain resilient. With this pattern playing out today, we see an attractive entry point for investors.  

  3. 3
    Consumer staples:

    This sector can play a valuable role in a defensive investing strategy, offering the potential for stable earnings, growing dividends and lower volatility. There may be particular opportunity today in companies that are able to raise prices without denting sales and that are doubling down on sales-and-marketing investments to help further boost revenues. As consumer companies recover from elevated commodities prices, expect to see improved profit margins for select companies. Consider stocks with attractive valuations and a history of healthy dividend payments. 

  4. 4
    Global dividend payers:

     Looking beyond the U.S., global dividend payers could offer greater portfolio diversification as international equities show continued momentum in recent performance relative to U.S. stocks. What’s more, international stock dividends tend to be higher, given that for many years U.S. companies have instead been prioritizing stock buybacks that help boost share prices.

Be Selective Among Dividend Stocks

Although dividend stocks can help to defensively position your portfolio, it’s important to remember that just because a company pays dividends does not necessarily mean it’s a great investment. Businesses can reduce or eliminate their dividends at any time. Notably, investors may want to avoid the highest-yielding dividend stocks, as that can be a signal of deteriorating financials and potential dividend cuts.

 

Investors should be selective and look for businesses that have strong management, high dividend-coverage ratios (i.e., a company’s net income divided by the dividend paid to shareholders) and strong free cash flow, as well as a track record of maintaining and even increasing their dividends throughout economic cycles. 

Ask your Morgan Stanley Financial Advisor how your portfolio may benefit from actively-managed exposure to dividend stocks. Learn more in this audiocast. Your Financial Advisor can help you access opportunities to invest in dividend-paying stocks that our strategists believe may generate strong total returns through varied market environments.

Find a Financial Advisor, Branch and Private Wealth Advisor near you. 

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More Insights

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Wealth Management Portfolio Insights Thoughts on the Market

Index Definitions

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

S&P 500 High Dividend Index is designed to measure the performance of 80 high yield companies within the S&P 500 and is equally weighted to best represent the performance of this group, regardless of constituent size.

S&P 500 Value:  Measure value stocks using three factors: the ratios of book value, earnings, and sales to price.

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Companies paying dividends can reduce or cut payouts at any time.International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets and frontier markets, since these countries may have relatively unstable governments and less established markets and economies.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Investing in small- to medium-sized companies entails special risks, such as limited product lines, markets and financial resources, and greater volatility than securities of larger, more established companies.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

The returns on a portfolio consisting primarily of environmental, social, and governance-aware investments (ESG) may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. The companies identified and investment examples are for illustrative purposes only and should not be deemed a recommendation to purchase, hold or sell any securities or investment products. They are intended to demonstrate the approaches taken by managers who focus on ESG criteria in their investment strategy. There can be no guarantee that a client's account will be managed as described herein.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.

The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes.  Morgan Stanley Wealth Management retains the right to change representative indices at any time.

Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance.

Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice.  Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.

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