Dividend Growth: What Should You Expect in 2016?

The tallest tree in the world towers over the Earth at nearly 370 feet in height. The tree is part of Redwood National Park in California and is estimated to be 700 to 800 years old. If you are aware of any dividend stocks with an equally impressive growth streak, please let us know 🙂

At it’s current pace of growth (about 50 feet every 100 years), the tree would reach the sky in roughly 3.3 million years. Of course, we know that trees can’t grow forever – at some point the tree doesn’t have enough internal pressure to pull water up from its roots all the way to the top of the tree, limiting growth.

All things have natural boundaries, and “trees don’t grow to the sky.” Unfortunately, neither do dividends.

Barclays, a multinational banking and financial services company, issued a research note earlier this week on the topic of 2016 dividend growth. The firm estimates that dividend payments made by S&P 500 companies grew 9% in 2015 to reach $380 billion, marking seven straight years of annual records for dividend payments. Barclays noted that even the energy sector reached a new all-time high for dividends in the third quarter of 2015 despite collapsing oil prices.

However, not all is well in the world. The basic materials and energy sectors are experiencing substantial earnings declines due to crumbling commodity prices, and the strong U.S. dollar is crimping reported growth for many multinational firms.

As a result, Barclays expects the S&P 500’s earnings per share to decline in 2015. As we know, dividend growth eventually needs to follow earnings growth to be sustainable. Due to the forecasted decline in earnings this year, Barclays predicts that dividend growth will fall to just 5% in 2016, recording its lowest rate of growth since 2010 and continuing the decelerating trend observed since mid-2013:

By sector, Barclays anticipates energy (-10%) and materials (-5%) to be the only areas with overall dividend reductions next year. The Financials and Technology sectors are anticipated to show the highest dividend growth rates in 2016. Several of the stocks highlighted in the note with above average dividend growth potential were AbbVie Inc. (ABBV), American International Group Inc. (AIG), Boeing Co. (BA), Bank of America Corp. (BAC), Citigroup Inc. (C), Ford Motor Co. (F), Kansas City Southern (KSU), Lowe’s Cos. Inc. (LOW), 3M Co. (MMM), and Wyndham Worldwide Corp (WYN).

We conducted an analysis using our Dividend Rating System to identify sectors with the safest and fastest-growing dividends. The first chart below shows each sector’s average dividend safety score. All but three sectors scored at least average (50 points) for dividend safety.

The three riskiest sectors for dividend safety in 2016 appear to be Transportation, Basic Materials, and Energy. In other words, our Dividend Safety Scores largely agree with Barclays’ conclusion – the materials and energy sectors face the greatest headwinds next year. Many of these companies are losing money and have dangerous balance sheets. The dividend will always be cut before a company misses an interest payment on its debt.

We also looked at Dividend Growth Scores, which estimate how quickly companies can grow their dividends going forward (scores range from 0 to 100, with scores of 50 being average). The sectors with the weakest dividend growth potential are energy, utilities, basic materials, and transportation. However, we see strong dividend growth potential within the business services and healthcare sectors, which often have more resilient earnings growth.

As always, dividend growth investors should maintain an awareness of their holdings’ finanical leverage and exposure to commodity prices. Since the financial crisis, we have been living in a world where debt levels don’t really matter and financing is extremely cheap, but this is no excuse for complacency.

We will remain focused on businesses that consistently generate free cash flow, operating in slow-changing industries with less macro risk, and maintain conservative balance sheets. Many of these types of companies can be found in our dividend portfolios or by using our Dividend Safety and Dividend Growth scores in tools like our dividend stock screener.