Thursday, February 24, 2005

Of Interest Rates and Dividends

We are continually asked if rising dividend stocks are more sensitive to rising interest rates than growth stocks. This is a good question for the times at hand because, as we have made clear elsewhere, we believe interest rates will trend higher in the coming year. The short answer is all securities are impacted by rising interest rates, at some level, because interest rates are in the denominator of all valuations formulas. But having said that, a good rule of thumb is that rising dividend stocks with higher than average yield and slow dividend growth (utilities and some REITs) are very sensitive to increases in long-term interest rates, while lower yielding, higher dividend growth stocks (ie, Johnson&Johnson and Procter and Gamble) are less sensitive to rising interest rates. The latter group, indeed, in many cases, have a negative correlation to rising interest rates--meaning that rising rates actually benefit them. This relative insensitivity to interest rates is one reason health-care, household products, packaged food, and some retail companies are considered to be "defensive" stocks. We have been adding companies from these sectors to our Rising Dividend Portfolio. We are seeing some shift to these kinds of companies in recent weeks. We believe there is more to come.