As I wrote in my previous post, Duration risk is the price risk sensitivity of a bond due to changes in market interest rates. What about dividend-paying stocks? Do they also have Duration risk? There have been many academic studies about this, and the conclusion is that dividend stocks do exhibit price risk similar to Duration risk in bonds.
Higher Dividend = Higher Duration Risk
This study by a couple of doctoral students concludes that stocks that pay a higher dividend exhibit traits that are consistent with a higher Duration risk. I use Finviz.com, a free stock charting site that also has a Screener function. With Finviz.com, you can screen for stocks that pay a dividend of 4% or over, for instance. (The dividend percentage is the last dividend paid per share divided by the current stock price). You can input other parameters as well, such as sector or market capitalization. In doing this, you can find stocks that pay 7%, 8% or even more.
There are stocks wherein dividends amount to the bulk of the total return you expect from investing in that stock, and there are other stocks wherein you invest hoping for price appreciation, and, oh, by the way, the company also pays dividends. Utility companies are examples of the former – stocks that pay relatively large dividends – and Microsoft is an example of the latter – growth stocks that also pay dividends. If interest rates go up or are expected to go up, you would expect that utility stocks would get hurt more than would Microsoft, because the dividend is so important to the total return to the utility stock investor. Thus, you could say that stocks that pay a higher dividend, or for which the dividend is more important, have more Duration risk than does a Microsoft, even though Microsoft’s current dividend rate is no small change at 1.86%.
Back to my Finviz.com example, when I do my screen for higher dividend stocks, and then sort by dividend yield, I would expect that the highest dividend-paying companies (in terms of dividend yield) would have more Duration risk than do the companies lower on the list.
Again, Why Should I Care?
This is important to you if you are seeking a higher yield and investing in dividend stocks as an alternative to traditional bonds or other fixed-income. Just because you are investing in stocks instead of bonds doesn’t mean that you are avoiding Duration risk. Dividend-paying stock prices are at risk if interest rates are seen to be on the uptrend, as they are now. Indeed, the Dow Jones Utility Index declined about 15% from early December 2017 through early February 2018, as interest rates ticked up. This is a real-life example of Duration risk in stocks.
Oil Stocks
Many of the large oil companies – the Exxons, Chevrons, Shells and the like – pay strong dividends, sometimes in the 4% to 5%-range. I don’t think these companies contain as much Duration risk as do other pure-dividend plays such as utilities and real estate investment trusts. The reason is that the companies themselves have opportunities for growth over and above what is offered through the dividend. Put another way, investors invest in Big Oil possibly for dividends but more so for the potential growth in the oil business. This is just my observation, not through the aforementioned study by the doctoral students.
IMO
My point is to give you another way of looking at dividend stocks and the inherent risks therein. If you are “reaching” for a dividend by investing in a company that pays a very high dividend, you must be aware that your investment is subject to Duration risk through a decline in price as interest rates rise. Lastly, I am not forecasting a rise in interest rates, but others are and the market narrative is that rates will rise. Let’s see how it plays out. Again, contact me if you want to explore this futher.