Dividend stocks have stumbled amid COVID-19: What does that mean for investors?

On the roller coaster ride that is the stock market, many dividend investors are used to a smoother trip.

That’s part of the appeal of owning stocks in large, established companies that reward shareholders by regularly distributing a slice of their earnings through dividends. Typically, when the stock market crashes, the tumble for shares of quality dividend-paying companies is a little less severe.

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So far, however, that hasn’t been the case through the COVID-19 pandemic.

In the first phase of the stock market downturn, Canadian dividend funds plunged just as much as the overall Canadian stock market, according to data from financial services firm Morningstar.

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And when stocks started to bounce back, dividend funds fell behind. To date, they’ve been lagging Canadian equity funds by an average of around 4 per cent, according to Morningstar.

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“The downside was comparable. But the recovery was not,” says Ian Tam, director of investment research at Morningstar.

The comparison is even less flattering when one looks at the so-called dividend aristocrats, commonly considered by investors as the upper crust of the dividend-paying stocks.

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In Canada, the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF, which tracks companies that have been increasing dividends for at least five years, was down a whopping 18 per cent year-to-date as of June 4 compared with a drop of less than 8 per cent for the iShares Core S&P/TSX Capped Composite Index ETF, which tracks the entire Canadian stock market.

Source: Morningstar. Source: Ian Tam, Morningstar Canada

On both sides of the border, the COVID-19 pandemic has hit some large dividend-paying companies hard. Canada’s big banks have seen their earnings plummet as they were forced to set aside massive contingency funds against the risk of loan defaults. In the oil patch, meanwhile, corporate giants have had to weather both the economic slowdown triggered by the lockdown restrictions and plunging emergency prices.

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Others, like grocery giant Loblaws, have seen a surge in sales as consumers rushed to stock up on essentials at the outset of the pandemic.

For now, it’s hard to say exactly why dividend funds have underperformed, Tam says.

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That may be little consolation to dividend investors, including a number of retirees who rely on dividends as a source of cash flow.

The main lesson here is “dividend stocks are stocks just like any other stock,” says Benjamin Felix, portfolio manager at PWL Capital in Ottawa.

“And stock prices can be volatile,” he adds.

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Focusing on companies with a long history of increasing dividends is a “very solid strategy,” says Rona Birenbaum, a certified financial planner and founder of Toronto-based Caring for Clients.

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But any strategy that focuses on a particular segment of the market comes with a higher probability of both overperforming and underperforming the market, she adds.

Felix warns that dividend investors sacrifice diversification by focusing on a smaller number of stocks in a smaller number of industries. This leaves them more exposed to risks that affect only certain companies or sectors of the economy.

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Dividend investors should also be prepared for the possibility of fluctuations in their dividend income, she notes.

While only a handful of Canadian-listed companies have cut or suspended dividends so far according to Morningstar, “that’s always been a risk,” Birenbaum says.

Investors who rely on dividends for income are giving up control of when and how to extract cash from their portfolios, Felix says.

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Since companies pay dividends out of their earnings, whatever cash investors receive and keep through dividend distributions is money that would otherwise be part of the capital they hold.

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Instead of selling some of their shares to generate cash, “you’re letting a corporate finance decision dictate your retirement spending,” he says.

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And receiving dividends from a company whose stock price has declined is like selling stocks in a down market, Felix notes.

Ultimately, investors should focus on a tax-efficient strategy based on quality investments that meet their objectives and that they can stick to, Birenbaum says.

Whatever you do, it’s never ideal to have to change course either because you discover you can’t stomach the volatility or because you need the money, she adds.

And that, holds for dividend-investing, too. Turns out it can have as many ups and downs as a regular rollercoaster ride.

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