For years, investors have gravitated to dividend-paying stocks as the best of all possible worlds. With the potential for price appreciation as well as reliable, predictable investment income, dividend stocks pulled in not just conservative investors looking to lock in gains from the bull market but also income investors who traditionally used bonds and other investments until their income dried up.
Now, though, the stock market has finally taken a turn downward, and dividend investors have noticed that many of their favorite names are taking losses they had hoped to avoid. Are dividend-paying stocks doomed to underperformance?
Which dividend stocks are getting hit hardest?
So far, we’ve seen some evidence that dividend-paying stocks are doing worse than the overall market since the latest pullback began. Going back to the end of April, the iShares DJ Select Dividend ETF , which has a high concentration of strong dividend payers, has fallen about 4%, compared to a more-or-less flat performance from the S&P 500 and other broader benchmarks.
By itself, a 4-percentage-point difference isn’t really big enough to get excited about. But certain stocks that are favorites among dividend investors have seen much more extensive declines. Utilities are extremely sensitive to interest rates, and most stocks across the sector have declined. Even with natural-gas prices on the rise and thereby helping to make its fleet of nuclear power plants more attractive, Exelon Corporation (NYSE:EXC) has sunk 18% since the beginning of May. Yet even in the more conventional utility arena, giant Duke Energy Corp (NYSE:DUK) has suffered a 12% drop, and other utilities have shared their double-digit percentage declines. For Exelon Corporation (NYSE:EXC), Duke Energy Corp (NYSE:DUK), and the rest of the industry, large levels of debt make them extremely vulnerable to future rate changes, and while interest expense won’t rise immediately, it will slowly go up as the companies have to refinance maturing debt at higher rates.
Master limited partnerships are also facing pressure. Kinder Morgan Energy Partners LP (NYSE:KMP) has declined almost 10% in the past month, with investors wondering whether the MLP’s yield will be sustainable in a higher-rate environment. Certainly, some of Kinder Morgan Energy Partners LP (NYSE:KMP)’s decline stems from company-specific news, including its decision late last month to cancel a proposed $2 billion pipeline that would have run from Texas to California. But other MLPs have seen more modest declines.