Have you ever wondered which sectors you should look in to find the best dividend stocks? With thousands of dividend-paying stocks to choose from, knowing where to begin the hunt for safe dividend income can feel overwhelming.
Not all stock sectors are equally attractive when it comes to dividend income. Some are characterized by short product cycles, rapid industry change, cyclical business trends, and capital-intensive operations. These sectors have less predictable cash flows and lack many of the traits we desire when searching for safe dividend stocks.
However, some sectors are much more likely to have companies that possess the traits we favor as long-term dividend investors. We like buying blue chip dividend stocks that have safe payout ratios, generate consistent free cash flow, dominate markets that have a slow pace of change, and maintain conservative balance sheets that help survive almost any economic environment.
Analyzing the Best Stock Sectors for Dividends
To begin our study, we pulled in dividend data for each sector. As seen below, we looked at each sector’s total number of dividend-paying stocks, median dividend yield, dividend growth rate, earnings payout ratio, free cash flow payout ratio, Dividend Safety Score, and Dividend Growth Score.
As a refresher, our Dividend Scores analyze a company’s balance sheet, payout ratios, recession performance, profitability, and more to determine the safety of a dividend payment and its growth potential. You can watch a short video here to learn more, but scores of 50 are average, 75 or higher is excellent, and 25 or lower is weak.
We can see that the Finance and Consumer Discretionary sectors contained the most dividend stocks and accounted for 35% and 10%, respectively, of the total number of dividend stocks in our database. We will now take a closer look at the best sectors for high yield, dividend growth, and safe dividend payments.
The Best Stock Sectors for Safe Dividend Stocks
We created a Dividend Safety Score that, you guessed it, measures the safety of a company’s dividend payment. From the table above, we can see that the best sectors for safe dividend stocks are the Consumer Staples, Business Services, Utilities, and Medical sectors with median Dividend Safety Scores of 78, 72, 65, and 64, respectively.
The Consumer Staples and Utilities sectors predictably scored high for dividend safety. Consumer staples companies typically benefit from strong brand recognition, the sale of non-discretionary products such as toilet paper, and slow-changing consumer tastes (in part due to the billions of advertising dollars spent by companies in the sector). Utility companies are very different businesses but generate equally reliable cash flows because consumers need their services and there are no alternative suppliers in most geographical regions.
The Business Services sector contains more of a mixed bag of companies. However, most of these businesses provide mission-critical services that companies choose to outsource. As long as they are doing the job well and cost-effectively, there is often little reason to change vendors. Switching costs can also be high in many cases depending on the service being provided. Within the Medical sector, many companies have advantages stemming from intellectual property portfolios, global distribution networks, regulatory compliance, and non-discretionary products that are needed to improve people’s health no matter what.
The Best Stock Sectors for High Yield Dividend Stocks
Chasing high yield dividend stocks is one of the easiest ways to get burned. Many times a high yield is a signal of distress and investors’ lack of confidence in the company being able to continue making its dividend payment. We typically become extra cautious when analyzing companies with dividend yields greater than 6%. However, some stock sectors are better than others when it comes to the hunt for yield.
The median dividend yield across all dividend-paying stocks in our database is 2.9%. The sectors with the highest dividend yields are Energy (5.5%), Utilities (3.5%), and Finance (3.1%). However, the high yield stocks in Energy look the most vulnerable to dividend cuts this year. Stocks in this sector have a dangerously low median Dividend Safety Score of 14, making them the riskiest sector for income in the market. We only own two oil producers across our Top 20 Dividend Stocks and Conservative Retirees portfolio, and both have Dividend Safety Scores nearly three times as high as the average Energy stock.
On the other hand, the high yields found in the Utilities and Finance sectors appear to be much more sustainable. These sectors have median Dividend Safety Scores of 65 (above average) and 51 (average), respectively. The Utility sector comes as no surprise. Many of these businesses operate like monopolies in the regions that they serve. They are the only option consumers have to purchase services from (at least until renewable energy sources such as solar become much bigger), and the services they provide meet essential needs that are paid for regardless of how well the economy is doing. Regulated utilities have their rates set by the government to ensure a basic return on their investment is attained as well.
Given the mature nature of the utility market and the high barriers to entry that further limit growth, they pay out more of their earnings in the form of dividends than other companies. The median earnings payout ratio of the Utilities sector is 64%, which is significantly higher than the median earnings payout ratio of all dividend stocks, which stands at 41%. As a result of these factors, Utilities have a weak Dividend Growth Score of 21 and have grown their dividends by just 3% per year over the last five years compared to an annualized dividend growth rate of 7% for all dividend-paying stocks. For these reasons, Utilities are most appropriate for investors living off dividends in retirement. Income-seeking investors might also have interest in our article from last year titled, “Are Utility Stocks in a Bubble?”
Dividend stocks in the Finance sector are collectively much safer than they have ever been. The financial crisis nearly wiped out some of the biggest banks in the world and ultimately forced many of them to be bailed out. As a result, regulatory bodies enforced much stricter capital controls on the industry. Today, many banks are extremely well capitalized and look to be in great financial shape.
In addition to banks, the Finance sector contains a number of real estate investment trusts (REITs) and insurance companies. Many REITs enjoy relatively stable cash flows given the predictable rents paid by the tenants of their properties. Well-managed insurance companies such as Aflac and Chubb can also be safe investments given their conservative risk management practices, non-discretionary services (insurance is needed regardless of how the economy is doing), well-established brands, and large distribution networks.
The Best Stock Sectors for Consistent Dividend Growth
In addition to looking at all stocks that currently pay a dividend, we took a look at the companies that have managed to consistently raise their dividends for at least 10 consecutive years. Almost any business can raise its dividend for a few years in a row, but it usually takes a company with numerous competitive advantages and favorable industry dynamics to keep growing its dividend for at least a decade or two. Many of the companies here are dividend aristocrats and dividend kings.
By conducting this study, we wanted to see which stock sectors have historically been the friendliest to dividend growth stocks. We grouped the roughly 350 dividend-paying stocks that have increased their dividend for at least 10 straight years by sector. Taking a look at the chart below, the Finance and Utilities sectors have the highest number of these companies, and the Transportation, Conglomerates, Construction, and Auto, Tires & Trucks sectors have the fewest companies with long-term dividend growth track records.
We further broke out these dividend stocks into the three groups seen below. The first group (green heading) consists of all 348 dividend-paying stocks with at least a 10-year dividend growth streak. The second group (pink heading) consists of the 191 dividend stocks with at least 10 consecutive years of dividend increases but fewer than 20 years of growth. The final group (blue heading) contains only the 158 dividend stocks with at least 20 straight years of dividend increases. Numbers in the table show how many companies from each sector are in each dividend growth category.
Finance, Utilities, Industrial Products, and Consumer Staples sectors accounted for about 66% of the total dividend stocks with at least a 20-year dividend growth streak. We already noted three of these sectors as being reliable areas for safe dividend income earlier, but Industrial Products is a new one.
Some industrial businesses are much better than others. Companies such as Parker-Hannifin and Emerson Electric have been excellent dividend growth stocks because they have successfully identified a number of high margin niche markets to dominate, built a reputation for quality, and grown a massive installed base of equipment using their parts which generates predictable aftermarket revenue to help them ride out cyclical ups and downs.
One of the other interesting things we noted in the table above was the significant difference in the number of companies in the Basic Materials and Energy sectors between the 10+ Year and 20+ Year dividend growth streak categories. These two sectors combined have 36 companies with a 10-year minimum dividend growth streak, but only 13 dividend stocks in these sectors are in the group with a minimum dividend growth streak of 20 years. In other words, unless “it’s different this time,” many of the commodity companies with 10+ year dividend growth streaks are unlikely to keep their streaks alive to eventually make the “20+ Year Dividend Growth Streak” bucket.
This major difference highlights a key element that all investors should be aware of: lucky macro factors can make certain businesses appear much better and safer than they really are. We are seeing this play out now with the broad shakeout in commodity prices. ConocoPhillips and BHP Billiton are just two of the major commodities giants to slash their dividends this year, and we expect more pain to come. Until the last few years, however, these businesses had been major winners from the (unsustainable) boom in commodity prices.
Closing Remarks: Stock Sectors Matter
While we typically pay little attention to macro factors when we invest, we can learn a lot just from being aware of the best stock sectors for dividend income and growth. Some areas of the market are naturally harder to build and sustain a profitable company for any number of reasons.
The best stock sectors for safe dividend income are the Utilities, Finance, Consumer Staples, and Business Services sectors. These three areas of the market collectively have more than 1,375 dividend stocks, and investors can use our dividend stock screener to screen in each of these sectors.
Some of the more challenging sectors to find high quality dividend growth stocks are Energy, Transportation, Basic Materials, Construction, Technology, and Autos, Tires & Trucks. It doesn’t mean that some great dividend growers cannot be found at all in these sectors, but the data suggests that these industries have less favorable conditions for long-term dividend growth.
We will leave you with a few thoughts on investing from Peter Lynch, Warren Buffett, and Charlie Munger. Essentially, the goal is to find a simple business that seems capable of earning high returns on capital, buy it, and give it time to compound in value. Investing primarily in sectors that possess more favorable operating conditions can give us a good head start.
“Never invest in an idea you can’t illustrate with a crayon.” – Peter Lynch
”Lethargy, bordering on sloth, should remain the cornerstone of an investment style.” – Warren Buffett
“If you don’t feel comfortable owning something for 10 years, then don’t own it for 10 minutes.” – Warren Buffett
“Time is the friend of the wonderful business, the enemy of the mediocre.” – Warren Buffett
“Investing is where you find a few great companies and then sit on your ass.” – Charlie Munger
Slicing it a bit differently; only 8.3% of the Finance group in the first list made your second list but 31.4% of the Utilities were there. Consumer Staples came in with a representation of 24.0% from the first list, Medical had a 20.2% and Industrial Products came in with 18.2%. Nearly a third of the utilities are on a ten year streak! Hmmm.
I enjoyed the article very much,especially your insight about the difference between those stocks within a sector that have a 20 yr. record versus those with only a 10 yr record.When I ranked the sectors by the percentage having 10 and 20 years streak compared to the total number of dividend paying stocks within that sector I found that Finance ranked 11th not first and Medical came in 3rd.I think Finance shows well in your ranking because of the much greater number of dividend paying stocks within Finance (1015). Despite having worked for a bank I
find large bank balance sheets impossible to analyze. Additionally given that the Finance sector has been becoming a much greater share of the S&P 500 the past 30-40 years and its severe problems in the recent past I wonder if other sectors are less prone to long term systemic issues. My thoughts may be more pertinent to the large banks as opposed to the many hundreds of smaller and mid-sized banks that continue to provide simpler and traditional banking services. Thank you for stimulating article.
Thank you for your comment, and I’m glad to hear you enjoyed the article. I agree with your commentary about banks – there are so many uncomfortable assumptions that go into their balance sheets, and leverage can swing either way. Wells Fargo is really the only one I am comfortable with, and at least the financial crisis is behind us. Best of luck with your investing!
Thank you, a very illuminating article.
I have two follow up questions:
1) I like your FCF Payout ratio as I don’t really trust payout ratios based on net income uie to all the possible financial shenanigans involved in getting there. I have been using payout based on Operating Cash Flow instead. FCF payout is likely superior than OCF though because it includes CapEx which can be wildly different and necessary between say a Utility and a Software company. However, FCF includes dividends paid so my question is do you back out dividends paid to make your calculation? It would obviously make sense.
2) Your analysis was done prior to S&P breaking out REITs as a separate sector. For all the wonderful stats for the Financial sector do REITs make up a good portion of them? I can see Banks having decent dividends NOW but, as far as consistency and safety of dividend I am highly leery (see Great Recession of 2008/2009).
Happy New Year, and thanks for your questions. Free cash flow does not include dividends paid, so there is nothing to back out in our calculations.
REITs account for less than 3% of the S&P 500. You can read more about their recession performance here: http://www.simplysafedividends.com/real-estate-investment-trusts-reits/