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  • Writer's pictureAlex Artenie

Master Dividend Stock Investing: How to Optimize Performance Along Economic Cycles

Updated: Jan 22

Dividend Stock Investing

Did you ever feel that your stocks follow a common trend altogether, regardless of what you are doing? Isn't it frustrating when you work on your dividend stock investing strategy and do your best to diversify, but all your positions still go red at once?

I think that happens to everyone from time to time. As an investor looking for long-term success, you must constantly deal with the fluctuating wave of economic cycles, including Expansion, Peak, Contraction, and Recession.

Dividend stocks are known to investors as investments in companies that regularly distribute a portion of their profits to shareholders and are sought after for their potential to provide steady income.

However, as an investor, you must understand that the performance of these stocks is linked to economic cycles, and your performance is likely to mirror them.

In this article, we will demystify how to optimize dividend stock investing versus the macroeconomy

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Economic Cycles and Dividend Stocks

The performance of dividend stocks generally varies based on the stage of the economic cycle. 

During the expansion stage of a bull market, dividend stocks typically exhibit robust performance. These companies generally see a boost in their profits during economic growth and, as a result, pay higher dividends.

For instance, during the recovery after the great financial crisis in 2008, many technology and consumer-focused companies, like Microsoft and Procter and Gamble, saw significant growth in their dividend yield related to the overall economic recovery. 

On the other hand, companies that pay dividends face significant challenges during economic downturns or the contraction phase of a cycle.

Generally, they tend to face decreased cash flows due to higher interest payments, lower revenue growth, and higher operating costs. As a result, some companies may cut dividends or, in extreme cases, suspend dividends altogether.

For instance, during the great financial crisis 2008, banks like Bank of America, Citigroup, and JP Morgan Chase significantly slashed their dividends in response to the mortgage crisis, as opposed to the high dividends they were paying just a few years prior during the expansion. 

In recovery periods, transitioning from trough to expansion, dividend stocks tend to gradually rebound. Once companies successfully navigate the downturn, they resume or increase their dividend payout as their financial health improves.

This whole phase typically sees firms being cautious but steady regarding their dividend growth, signaling a gradual economic recovery. 

Dividend Stocks During Economic Cycles

Decoding Sector Influence on Dividend Stock Performance

The performance of dividend stocks during economic cycles generally depends on the sector, primarily influenced by the nature of their business and market demand. 

For instance, companies in the technology sector outperform during the expansionary phase due to rapid innovation and growing consumer demand.

A prime example of this is iPhone maker Apple, known for its constant dividend growth. The company has continued to innovate and adapt to evolving market trends, having grown its dividend payout by 46% over the past five years

During economic downturns, Utilities are generally considered a haven. Companies like Duke Energy can maintain steady cash flows due to the consistent demand and regulatory environment, which enables them to pay dividends consistently. 

Conversely, sectors such as Retail, Travel, and Consumer Discretionary are more sensitive to economic downturns, struggling especially during contractions. For instance, during the pandemic in 2020, retailer Macy’s suspended its dividend due to drastically reduced consumer spending and the closure of physical stores due to the lockdowns.

Even companies in the industrial sector, such as Ford and General Motors, tend to get cautious during downturns and suspend or reduce dividends due to the reduction in demand.

Finally, companies in the consumer goods sector have mixed performance. Thanks to constant demand, companies that supply essential products, like Procter and Gamble, tend to perform well and sustain dividends, even during downturns.

However, companies focused on non-essential consumer goods struggle and slash dividends during economic contraction. 

Strategies for Dividend Investing Through Economic Cycles

Investors looking to benefit from dividend stocks can generally employ either long-term or short-term approaches. Short-term strategies involve trading dividend stocks based on economic trends and include buying stocks before they announce dividends or shorting the stocks of companies that may cut dividends going into the downturn.

Long-term strategies involve picking and investing in stocks with a consistent history of growing dividends, regardless of economic cycles. The long-term strategy is rooted in the belief in choosing resilient and stable companies, making them suitable for a long-term portfolio

Warren Buffet and Berkshire Hathaway are known for their successful long-term buy-and-hold strategies. Berkshire specializes in high-quality companies demonstrating financial stability and a commitment to rewarding shareholders through dividends. Over half of Berkshire's holdings pay dividends, with several yielding near 4% or higher, possibly indicative of financially healthy businesses.

Warren Buffett Highest Yield Dividend Stocks

A few other companies in Berkshire’s portfolio include Coca-Cola, which the company invested in the late 1980s. Coca-Cola is an iconic brand and recession-proof business and has been a dividend giant, consistently increasing its payouts over time.

Another instance is Chevron, which is Berkshire's third-largest holding by value. Chevron has been resilient, with 2023 being marked as the 36th consecutive year with an increase in annual dividend payout per share.

Diversification is key in managing risks associated with dividend investing. Investors should not concentrate on high-yield stocks but should spread their investments across different sectors. It is crucial to balance a portfolio with a mix of high-yield and growth-oriented dividend stocks can be effective.

Dividend investment strategies used by hedge funds and investment managers vary widely, involving a blend of financial instruments and risk management techniques.

One such strategy is the Triple Income Formula, which seeks to maximize income through high-quality dividend stocks combined with conservative option strategies like cash-secured puts and covered calls.

This method relies heavily on stock selection and aims to generate more income with less downside risk compared to a traditional buy-and-hold dividend stock portfolio.

Dividend Stock Investing: The Bottom Line in Economic Cycles

Dividend-focused stocks perform differently based on the various sectors during the economic cycles, each responding uniquely to the challenges and opportunities presented by the economic environment.

Investors must maintain flexible investments in dividend stocks, accounting for emerging trends and fundamental market shifts. 

Whether you decide to invest only long term by picking stocks to hold forever or if you prefer to rotate your dividend portfolio as the economic cycles move, that is completely up to you.

I personally prefer to have a mix of both strategies.

I hope this article was helpful for you and it will help you become a better investor!

Following my Dividend Horizon,

Alexandru Artenie


FAQ about Dividend Stock Investing

Should I Invest in Dividend Stocks?

Dividend investing is known as a reliable investing strategy. First, it provides a stable source of income stream that keeps putting money in your pocket. This happens by itself, while you do not have to lift a finger, i.e., your involvement after the stock purchase can be reduced to zero.

Secondly, dividend payment is considered a sign of financial health and can represent a stock selection criteria by itself.

As Peter Lynch said in his outstanding book, "Beating the Street," "The dividend is such an important factor in the success of many stocks that you could hardly go wrong by making an entire portfolio of companies that have raised their dividends for 10 or 20 years in a row."

-Lynch, Peter. Beating the Street (p. 60). Simon & Schuster. Kindle Edition.

Where to Invest in Dividend Stocks?

Any investment brokerage firm that allows you to purchase stocks and lets you buy dividend stocks. There is no separate market for dividend-paying companies versus non-paying.

How Much to Invest in Dividend Stocks?

This depends on your particular financial goal. You need to have your portfolio balanced in order to expect a good performance. Try to diversify. Even if your entire stock portfolio consists of dividend payers, make sure that you allocate a part of your funds also to other asset classes, like Bonds or Real Estate. This will help you secure your returns and spread your risk.

For your reference, my portfolio consists of about 30% dividend-paying stocks and ETFs.

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