Why 2026 Could Be a Breakout Year for Dividend Stocks I December 1, 2025

Key Concepts

• Dividend Stocks: Stocks that pay a portion of a company's profits to shareholders.
• Total Return: The combined return from capital appreciation and dividend income.
• Dividend Yield: The annual dividend payment divided by the stock's price.
• Stock Buybacks (Share Repurchases): When a company buys back its own shares from the open market.
• Dividend Growth Investing: A strategy focused on companies that consistently increase their dividend payments over time.
• Payout Ratio: The percentage of a company's earnings paid out as dividends.
• Economic Moat: A company's durable competitive advantage that protects its profits from competition.
• Distance to Default: A quantitative measure of a company's financial health and its likelihood of defaulting on its debt.
• Value Investing: An investment strategy that involves buying stocks that appear to be trading for less than their intrinsic or book value.

Performance of Dividend Stocks in 2025

Main Topics and Key Points:

• As of November 19th, 2025, most Morningstar dividend indexes have performed well in absolute terms but have lagged the overall US equity market by a few percentage points.
• The primary reason for this underperformance is the significant outperformance of technology and AI stocks within the broad US market.
• The broad US equity market is heavily weighted towards technology and AI stocks, with Nvidia alone surpassing $5 trillion in market capitalization, significantly impacting overall market returns.

Sectoral Variations in Dividend Stock Performance:

• Strong Performers:
  • Utilities: Have experienced a significant turnaround, transforming from a traditionally "boring" and bond-like sector into a growth sector. This is largely attributed to increased power demand driven by AI processing.
  • Financials: Show a mixed but generally decent performance. Large money center banks (e.g., JPMorgan, Bank of America), credit card companies, and insurers have performed well. Elevated interest rates and a robust economy have been supportive, along with deregulation acting as a catalyst.
• Struggling Performers:
  • REITs (Real Estate Investment Trusts): Have been negatively impacted by higher interest rates, which have weighed on the overall property market. Challenges include a slow residential housing market and the ongoing impact of hybrid work on office real estate and e-commerce on commercial properties.
  • Energy Stocks: Have struggled due to lower oil prices, driven by oversupply and some weakness in demand.

International Dividend Stocks vs. US Dividend Stocks

Main Topics and Key Points:

• International stocks, in general, have outperformed US stocks year-to-date.
• This outperformance extends to the dividend segment, with international dividend stocks outperforming broad international markets, a contrast to the US market.
• Key Drivers of International Outperformance:
  • Lower Technology Exposure: Technology stocks constitute a smaller portion of international markets compared to the US.
  • Larger Financial Services Sector: Financial services, which are dividend-rich, represent a larger segment of international markets and have performed well.
  • Currency Depreciation: The depreciation of the US dollar has amplified returns for US investors holding unhedged international stocks.
  • Strong Performance in Europe and Emerging Markets: These regions have seen significant gains, with European banks, in particular, performing strongly.
• Historical Advantage: The outperformance of international dividend stocks has been a longer-term trend, not just a 2025 phenomenon.

The Stock Buyback Boom and its Implications for Dividend Investors

Main Topics and Key Points:

• Definition of the Boom: The trend of companies spending more on share repurchases than on dividends has been ongoing for two decades, with 2025 being the fifth consecutive year this has occurred.
• Financial Scale: Approximately $1 trillion is expected to be spent on buybacks in 2025, compared to $750 billion on dividend payments.
• Reasons for Buybacks:
  • Tax Advantages: Dividends are taxed when received in taxable accounts, whereas buybacks increase a shareholder's fractional ownership without immediate tax implications if shares are not sold.
  • Flexibility: Buybacks are more opportunistic and can be executed when a company has excess cash or when shares are undervalued. Dividends, conversely, represent a commitment that, if reduced or eliminated, can lead to market punishment.
  • Cultural Preference (Technology Sector): Technology companies, particularly in Silicon Valley, often view dividends as "old economy" and prefer buybacks, seeing them as a more modern way to return capital.
• Impact on Dividend Investors:
  • Lower Yields: The prevalence of buybacks has contributed to a decline in the overall dividend yield of the US equity market, which has fallen from historical levels of 3-6% to around 1.1%. This makes it harder for investors to generate equity income from US stocks.
• International Contrast: The stock buyback boom has been largely a US phenomenon. Buybacks are less popular overseas due to:
  • Less severe market punishment for dividend reductions.
  • Less significant tax advantages compared to the US.
  • A greater emphasis on dividend commitments in many international markets.

Tax Implications for US Investors in International Markets:

• US investors considering international dividend stocks for higher yields (e.g., exceeding 3% on the Morningstar Global Markets XUS index compared to 1.1% in the US) must be aware of potential tax implications, including the possibility of double taxation on dividends.

Identifying Sustainable Dividends

Main Topics and Key Points:

• Given the shrinking dividend income in the US, it's crucial for dividend investors to ensure the security of their dividends and avoid companies on the verge of a dividend cut.
• Dividend History: While not unimportant, dividend history can be overemphasized. Long-standing dividend records do not guarantee future sustainability. Examples of companies with long dividend histories that have cut their dividends include Dow Chemical, Walgreens, 3M, Intel, and Shell Oil.
• Consequences of Dividend Cuts: A dividend cut is often a sign of broader financial trouble and is typically accompanied by a reduction in share price.

Forward-Looking Metrics for Dividend Stability:

1. Payout Ratio:

   • Definition: The percentage of a company's earnings paid out as dividends.
   • Indicator: A high payout ratio can signal unsustainability.
   • Morningstar's Threshold: Morningstar's dividend indexes screen out companies with payout ratios exceeding 75%, considering them risky.
   • Industry Variation: While theoretically, sectors with more predictable earnings could sustain higher payout ratios, investment dynamics are constantly changing, making a consistent threshold practical.

2. Economic Moat:

   • Definition: A metaphor for a company's durable competitive advantage that protects its profits from competition (coined by Warren Buffett).
   • Relationship to Dividend Stability: Companies with economic moats tend to sustain their dividend payments better than those without.
   • Morningstar Ratings: Morningstar uses "none," "narrow," and "wide" moat ratings.
   • Research Finding: Companies with economic moats demonstrate greater dividend stability.

3. Distance to Default:

   • Definition: A quantitative measure of financial health that incorporates balance sheet information, equity value, and equity price volatility. It assesses the market's perception of financial distress.
   • Accessibility: This metric is not easily accessible to individual investors.
   • Index Application: Morningstar's "Dividend Yield Focus" index utilizes both economic moat and distance to default measures. This index was built in 2010, post-financial crisis, with a defensive orientation to identify companies capable of sustaining dividends and maintaining financial health.

Example Companies in the Dividend Yield Focus Index (as of November 19th, 2025):

• Merc
• Pepsi
• Kenvu
• Alliant Energy

These companies are noted as being attractively valued and within the Dividend Yield Focus index, suggesting potential dividend stability and attractive price multiples.

Dividend Growth Investing

Main Topics and Key Points:

• Strategy: Targets companies that consistently increase their dividend payouts to shareholders.
• Underlying Rationale: Companies increasing dividends are often seen as strong, with improving prospects, high quality, and robust competitive positioning (potentially with economic moats).
• Defensive Orientation: Dividend growth strategies are known for their defensive characteristics, exhibiting less volatility than the broad equity market.
• Performance in 2025: Similar to other dividend stocks, dividend growth stocks have lagged the broader US market by a few percentage points, again attributed to the AI and technology rally.
• Stability During Sell-offs: Dividend growth stocks have historically held up better during market downturns (e.g., 2022, 2018) compared to the broad market.

Evolution of the Dividend Growth Universe:

• Increased Technology Exposure: There is a growing presence of technology stocks within the dividend growth universe.
• Examples: Apple, Microsoft, Applied Materials, Broadcom, and Oracle are mentioned as technology companies that pay dividends and are included in dividend growth indexes.
• Yield Characteristics: Many of these technology dividend growth stocks offer lower yields compared to traditional dividend payers.

Expectations for Dividend Growth Investors:

• Dividend growth strategies are expected to perform in between the broader market and high-dividend-paying stocks.
• When high-dividend stocks outperform, dividend growth tends to lag but still perform better than the market.
• When the market performs strongly, dividend growth tends to lag the market but not as significantly as high-yielding equities. This general performance pattern is expected to continue.

Outlook for Dividend Stocks in 2026

Main Topics and Key Points:

• US Equity Market Valuation: Morningstar's research teams view the US equity market as "frothy" overall, with particularly rich valuations in the technology and AI-related sectors.
• Attractive Valuations: Valuations are considered more reasonable in the "value" segment of the market, where many dividend-paying stocks are found. Small-cap stocks are also identified as an attractive area.
• Potential for Volatility and Rotation: The speaker anticipates further volatility and potential rotations in the market.
• Dividend Payers' Potential Performance: Dividend payers are expected to perform well, especially during periods of market downturns or rotations away from high-growth sectors. This was observed in 2022 when technology stocks sold off dramatically, and dividend-paying stocks held up well.
• Long-Term Perspective: Dividend investing, whether dividend growth or high yield, is considered a sound strategy for participating in the equity market, particularly for income generation and as a defensive approach.

Conclusion/Synthesis:

The discussion highlights that while US dividend stocks have lagged the broader market in 2025 due to the AI-driven technology rally, they have demonstrated resilience and offer attractive opportunities, especially in international markets and within specific sectors like utilities and financials. The rise of stock buybacks has contributed to lower US dividend yields, making international diversification and a focus on dividend sustainability crucial. Investors seeking secure dividends should look beyond historical performance and consider metrics like payout ratios, economic moats, and financial health indicators like distance to default. Dividend growth investing remains a viable strategy, offering a balance between growth and stability, with an increasing inclusion of technology companies. Looking ahead to 2026, a more cautious outlook on US equity valuations, particularly in tech, suggests that dividend-paying stocks, often found in value segments, may offer a more attractive risk-reward profile and potential for outperformance amidst market volatility.