The dividend yield of Eurozone equities exceeds by far the yield on investment grade corporate bonds. On top of this higher yield, we do not see a lot of dividend risk for the coming year. On the contrary, dividends will probably rise further in line with expected 4-11% earnings growth.

European dividend stocks had a good start of the year

The Search for Yield Revisited
Source: Thomson Reuters Datastream, ING IM (total return, 01/01/15 – 06/02/15)

Investors looking for predictable dividend stocks

From a historical perspective, cyclical equities perform well in periods of QE. In the US, the UK and Japan, cyclical stocks outperformed defensives in the six months following a QE announcement. However, in the Eurozone this has not been the case so far, despite the fact that the ECB’s QE program exceeded expectations. On the contrary, January sector performance was characterized by a shift towards defensive sectors. Top performers were Health Care, Consumer Staples, Utilities and Telecoms. Common denominators are earnings and dividend visibility.

The search for dividend yield has intensified since the ECB news which pushed government bond yields in the Eurozone to historic lows and in several cases even into negative territory. EUR 1.4 trillion of Eurozone bonds now yield negative returns. We think this trend may continue as long as we see no upward shift in the treasury yield.

View on safety of dividend payment is important

Of course, dividend growth is not equally spread amongst sectors and regions. Simply going after the highest yield may lead to buying into value traps whereby, due to a lack of growth prospects, cheap valuations continue to become ever cheaper. Telecoms, Utilities and now also the Energy sector run the highest risk of ending up in this corner as earnings growth is low, investment (capex) needs are high and cash flow is under pressure. In other words, buying dividend income also requires a view on the safety of that dividend payment.

We see the lowest risk in Technology and Consumer Discretionary. This last sector is currently our favourite, as consumers get an additional boost in their purchasing power from the fall in the oil price. The sector should also benefit from the improvement in credit growth in the Eurozone.