Dividend Dynamo or Dividend Yield Trap?

Over the last several trading sessions, the market has been primarily driven by trade and geopolitical headlines first, economic data second, followed by corporate earnings. Driving the headlines include not only the renewed U.S.-China trade war, but also U.S.-Iran tensions. We also have the realization that, after six weeks of talks, we are no closer to a Brexit deal, with Prime Minister Theresa May set to depart during the first week of June. There was some trade relief as we headed into last weekend, with President Trump stating Friday he would delay tariffs on imports of cars and car parts from allies like Europe and Japan for six months. So, while the market enjoyed some relief last week on this news, the focus is back on U.S.-China trade following comments from China that until the U.S. is sincere when it comes to trade talks, it is meaningless for its officials to come to China and have trade talks. This could devolve into a Twitter version of the game of no, you first commonly seen on schoolyard playgrounds, so investors should continue to watch for signs of progress ahead of the Group of Twenty meeting in Japan next month, at which China's president, Xi Jinping, and Trump are expected to meet. As a reminder, those two heads of state met in Argentina during December and were able to put trade negotiations back on track. Hopefully that will be the case again. If not, it means the investment community will have to factor the impact of the recent tariff hike and pending ones on growth expectations for the economy and corporate earnings. Barring signs of reprieve, the likely revision will be downward. And as if that wasn't enough on the average investor's plate, we are now moving into the second half of the quarter, with larger tariffs on Chinese goods and China soon to slap tariffs on U.S. goods on June 1. The big question in the coming weeks will be the impact of the tariff war on the global economy and corporate earnings. For the current quarter, we are seeing GDP expectations move lower on the heels of recent economic data, and yes, that is before the impact of tariffs just mentioned. For the June quarter from an earnings perspective, consensus EPS for the S&P 500 is expected to grow 5% sequentially, but fall 1% year over year. Again, as more economic data, as well as the balance of corporate earnings and tariffs, are factored into the forecast equation, we're likely to see further movement in those expectations. With flat EPS growth year over year for the March quarter, and a modest dip for the current one, it means earnings in the back half of the year will need to grow 11% to hit the consensus view, which now calls for more than 4% EPS growth for the S&P 500 in 2019. And yes, that consensus has yet to be meaningfully adjusted to account for the coming impact of trade tariffs. What this likely means is, depending on the length of time these new tariffs are in place, EPS expectations for the second half of 2019 will have to come down. Currently the S&P 500 is trading at roughly 17x 2019 EPS, and depending on the degree of revisions to be had for the coming quarters, that could lead the market to have limited upside from current levels. With that analysis running through investors' minds, there is a high probability they are looking for safe-haven stocks, which can take several forms. One potential safe haven group are defensively positioned companies that are growing their earnings faster than the S&P 500, and trading at a discount relative to the market multiple. Hand in hand with that are dividend dynamo stocks that have a track record for increasing their annual dividend payment to shareholders. Some of the best-known ones include The Coca-Cola Co. , PepsiCo, Inc. , International Flavors & Fragrances Inc. and one of my personal favorites, McCormick & Co. . One trap that investors looking for safer ports of call should avoid is too good to be true dividend yields. Two examples are GameStop Corp. and Barnes & Noble, Inc. . While GameStop shares sport a dividend yield near 15%, its core business continues to dwindle as consumers flock to gaming via app stores and smartphones. According to a new survey by the Entertainment Software Association (ESA), while PCs and game consoles remain popular, 60% of gamers play on their smartphones. And that's before Apple Inc.'s Apple Arcade debuts, which should bring 100 new and exclusive games to iOS and MacOS devices. There is also Alphabet Inc.'s Google Stadia, which will offer console quality streaming games as well as rumored streaming gaming offerings coming from Microsoft Corp. . The gaming deck is stacked against GameStop, and it's being reflected in its declining revenue. The story is a similar one with Barnes & Noble, whose shares offer an 11% dividend, primarily because the share price has continued to crumble in recent months. The company's business model has been under attack for some time as consumer shift to digital downloads of books and magazines. Management has tried, first with an emphasis on gifts and collectibles and more recently with a café strategy. Neither strategy helped spur book sales. And data inside the April retail sales report doesn't paint a good picture either for the company. The moral of the story is when looking for safer ports of call during turbulent market times, investors tend to circle back to dividend-paying stocks, but you still need to do your homework. That means understanding the trajectory of the underlying company's business model -- is it vibrant and growing or stagnating and likely to burn through cash? If it's the latter, better to move on than fall for a dividend yield trap.

Dividend Dynamo or Dividend Yield Trap?

Investors on the hunt for safe-haven stocks need to be wary of dividend yields that look too good to be true.

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