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Why Growth Trumps Yield in Dividend Investing

Investors are going further afield in their search for income in this environment of low—and even negative—rates. Stocks have become one popular choice, but investors should focus more on companies that can consistently grow their dividends, rather than chasing the highest yields.

Some traditional dividend sectors like utilities and consumer staples have gotten a bit expensive amid the hunt for yield. But there are still some opportunities for finding income in the stock market. After all, the dividend yield on the S&P 500 Index is higher than the yield on 10-year Treasurys, although investors should remember that stocks are generally more volatile than bonds.

If investors are selective with dividend stocks, they may be able to realize an attractive total return through a combination of capital appreciation and dividend income. We favor high-quality companies with strong balance sheets that can sustain dividends, even if the yield isn't as big as the highest yielders. Our view is that being able to sustain and grow dividends is what makes an attractive stock.

Dividend-paying stocks with the highest yields have not been the best performers, according to Eaton Vance research. We separated the dividend-paying members of the S&P 500 into quintiles and analyzed their performance between 1990 and 2015.

We found that the highest-yielding stocks in the first quintile were historically the weakest companies that had a tough time sustaining their high dividends. Instead, the second-quintile group was comprised of the best performers during the 25-year period. The companies in the second quintile tended to be high quality with attractive valuations that also sustain and grow dividends over time.

We believe that tilting to dividend growers is more important than ever because dividend investing has changed since the financial crisis. Not so long ago, investing in high-dividend stocks was a form of value investing. In general, it now contains more risk and less value.

Michael Allison is vice president and equity portfolio manager at Eaton Vance Management. Additional insights regarding income, volatility and taxes can be found on the Eaton Vance Advisory blog

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