It's official. Investors have begun to fear that interest rates will soon rise. Bond prices have increased and we've witnessed a sell-off of stocks. Is the party over for dividend-paying stocks?
Time to sweep up the confetti?
When interest rates are high, conservative investors can buy relatively safe securities, like government bonds, and live off the income they produce. When rates are low, as they've been during the past several years, the income investors receive drops sharply, making dividend-paying stocks much more attractive. So, with the recent belief that the U.S. economy is strengthening, should investors flee dividend-paying stocks?
In a word: no. The rise in rates won't happen overnight, and rates will need to rise significantly before dividend yields on stocks become unattractive. Right now, the average dividend yield of S&P 500 stocks stands at 2%, twice the yield of a five-year Treasury.
But the real power of dividend-paying stocks is that bonds simply cannot compete when it comes to generating rising income, an essential component of a retiree's portfolio. That's what allows you to pay for gas and groceries a decade from now. Good, quality companies keep increasing their dividends. Rising dividends on top of high yields is an unbeatable combination.
Look to the S&P 500 Dividend Aristocrats, companies that have raised their dividends for at least 25 straight years, for good examples. Procter & Gamble (NYSE:PG) has been paying a dividend for 123 consecutive years and has increased its dividend for 57 straight years. Even though P&G currently pays an already-enticing 3.1% dividend, the consumer products powerhouse has increased it by 50% in the past five years and recently declared a 7% dividend increase.
Even though P&G's Gillette, Tide, and Pampers brands are some of the most reached-for and well-recognized global products, the company has recently struggled to maintain its top-dog status in the consumer products sector. As part of the company's plan to improve performance, P&G announced earlier this week that it's regrouping its business units into four industry-based divisions.
Don't overlook dividend-paying stocks that pay lower yields yet boast reliable dividend growth. Through construction and housing market booms and busts, Lowe's (NYSE:LOW) has consecutively increased its dividend for 50 years. Even though the home improvement retailer pays a modest 1.5% dividend yield, it raised its dividend by more than 14% last year and has more than doubled it during the past five years. Better yet, Lowe's payout ratio, which indicates how much of its net income is returned to shareholders in dividends, is 37%, meaning the company has plenty of room to grow its dividend in the future.
Lowe's enormous dependence on the housing industry hurt it during the recent recession. But the company, which caters to contractors, DIY-ers, and do-it-for-me types, is benefiting greatly from the current housing market recovery.
Another example is Target (NYSE:TGT). This friend to the trendy consumer has hiked its dividend for 45 consecutive years. The stock pays a 2.1% dividend yield, and Target's payout ratio is 32%. The company has significantly increased its dividend over the past five years. In fact, Target raised its dividend 125% during the past five years. No bond can give you that kind of pay raise.
Target recently branched out into the Canadian market. The large capital investments required will initially reduce Target's cash flow. But over the long-term, the retailer will likely enjoy improved cash flows as the Canadian stores become more established.
Final Foolish thoughts
Interest rates won't rise meteorically overnight. If you own high-quality dividend-paying stocks, don't let fear drive you to sell a perfectly good investment. Keep the end goal -- reliable and rising income for years to come -- in mind.
Fool contributor Nicole Seghetti owns shares of Procter & Gamble and Target. Follow her on Twitter @NicoleSeghetti. The Motley Fool recommends Lowe's and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.