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Where to look for dividends in the current market downturn

With our stock market losing plenty of value, the historical dividends are suggesting that many stocks are trading at a very attractive dividend yield. However, this may be a value trap on many stocks, who are unlikely to maintain the same dividends that they paid over the past year.

Indeed, the European Central Bank as well as the Reserve Bank of New Zealand has moved to stop the banks operating in their jurisdictions from paying dividends to shareholders for the time being. The Bank of England also managed to convince banks not to pay dividends for this financial year, as well as to cancel any share buybacks.

The moves are an attempt to promote high capital buffer levels, meaning that if bad debts and default increase, the banks should be in a better position to absorb those losses. This does call into question the dividends of ASX listed banks however, especially considering that they rely on dividends from their New Zealand subsidiaries to pay some of the dividends they deliver in Australia.

Plenty of other companies will also take enough of a hit to earnings that their dividends will be reduced for the periods ahead. Indeed, some stocks have already deferred or even cancelled previously announced dividends. There are plenty of Australian dividend stalwarts that have indicated they are unlikely to pay anything near what their historical dividends have been. As a result, where our ASX 200 would be yielding around 7 percent based on prior dividends at this price level, analysts expect this will actually turn in to a dividend yield of around 4.5 to 5 percent once the deferred, lowered, cancelled, and reduced dividends have been announced.

So that prompts the question, what dividends will hold up? I’ve separated stocks that may maintain strong dividends into three different categories. These are defensive, counter-cyclical, and simply just fortunate stocks that should be able to maintain earnings and thus shareholder returns.

DEFENSIVE: Defensive stocks are stocks whos’ businesses aren’t affected too much by the economic cycle. That is, they should perform similarly in an economic downturn as they do during strong economic times. We’ve likely seen this reflected in the continued demand at supermarkets, but some utilities, such as telecommunication services are also likely to remain fairly consistent. Therefore, stocks like Telstra (TLS), Coles (COL), and Woolworths (WOW), are fairly defensive stocks that should be able to at least maintain dividend payments this year.

There are also many healthcare stocks that operate very defensive businesses, but often the dividend yields presented by these companies are not overly attractive due to the high share prices.

COUNTER-CYCLICAL: Counter-cyclical stocks are stocks that should outperform during periods of economic downturn. The most prominent class of counter-cyclical stocks on our market are the gold stocks. Whilst it’s worth noting that gold hasn’t risen as sharply as might be expected during this downturn, it’s also worth noting that gold was already at very strong prices before the sell-down. Regardless, gold prices have increased since equity markets peaked in February and Australian dollar gold prices have increased significantly more (due to the Australian dollar falling relative to the US dollar). In some cases, costs of production may also come down for producers due to declining oil prices.

There are not a whole heap of strong yielding gold stocks on the ASX, but there are some. Regis Resources (RRL), St Barbara (SBM) are two gold stocks that have paid attractive dividends relative to their current share prices and I suspect that those dividends will at least be maintained, or more likely, increased, in the second half of this year.

FORTUNATE: Sometimes there is a downturn that leaves certain sections of the economy untouched, where usually they would suffer. Each downturn has companies fortunate enough to weather the storm simply because the current crisis doesn’t affect them, or the markets in which they operate show unlikely resilience through the tough times.

Few sectors of the ASX have been more fortunate than the iron ore miners, who have benefited from iron ore prices remaining strong, as well as the Australian dollar weakening. These miners have also benefited specifically from the largest non-Australian producer (Brazilian firm Vale SA) reducing its production, as well as the Chinese government engaging in infrastructure-based stimulus projects. The big iron ore miners of Fortescue (FMG), Rio Tinto (RIO), and BHP (BHP) are therefore strong dividend candidates for the periods ahead.

With interest rates at or near zero percent in much of the developed world, investors, and particularly retired investors are reliant more and more on dividend payments. This current economic downturn is therefore a large threat to the essential incomes of a great many people. It may therefore be fruitful to start looking for strong dividend payers while prices remain depressed.

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