By mid-november 2023, the S&P 500 had advanced nearly 15% for the year. That performance was largely driven by a handful of growth stocks in the tech and travel and leisure sectors.

But for investors who favor stocks that pay dividends, it’s been a tough year, thanks partly to rising interest rates. Experts say that’s about to change.

“2023 has provided a challenging backdrop for dividend-paying companies,” says Tom Huber, portfolio manager of T. Rowe Price’s Dividend Growth Fund and Dividend Growth ETF. “As of the end of Q3, non-payers outperformed dividend payers by 26%. … However, this is providing us significant opportunity in dividend-growth companies, which we believe can continue to compound value over the long term—and many of which are trading at only market-like multiples or less.”

In other words, these stocks are undervalued. “There are attractive, relatively high dividend-paying stocks in most sectors,” says Eric Beyrich, chief investment officer at Sound Income Strategies in New York City.

He cites telecom giants like AT&T and Verizon, as well as Omnicom Group and Interpublic Group, two New York-based communications-services providers. He also mentions consumer staples such as Molson Coors Beverage Co. and Chicago-based packaged-food producer Conagra Brands.

“The way to find [such opportunities] is to look at the areas that have underperformed the most, on a price basis, as that tends to lift the yields,” he explains. “Then look for companies with scope for improvement.”

Beyrich is not alone in his view on the market overall, though different investors have varying views of the particulars.

Defensive Sectors
“As a result of the stock market’s flight to riskier assets this year, which came about on expectations of a soft economic landing, many defensive sectors are now offering attractive relative valuations,” says Burns McKinney, portfolio manager of the Virtus NFJ Dividend Value Fund. “These sectors also offer attractive yields.”

At the same time, he says, the industrials sector offers “solid dividends and secular tailwinds.” Infrastructure spending by government programs is ramping up, he adds, and geopolitical uncertainty favors rising defense outlays—two trends that should benefit industrial companies.

Michael Clarfeld, a portfolio manager at ClearBridge Investments in New York City, shares a similar sentiment. “Some sectors that have sold off in 2023 as interest rates rose look attractive right now,” he says, singling out so-called bond proxies such as utilities, REITs and energy infrastructure companies. These have “come under some knee-jerk selling pressure as investors extrapolate the consequences of higher rates,” he says.

He has reduced his exposure to “high-multiple names,” he says, and instead favors lower-priced dividend growers. Specifically, he likes two energy infrastructure providers: Sempra, a San Diego-based company whose stock has been basically flat this year, and Enbridge, a Calgary, Alberta, company whose shares were down about 13% for the year by mid-November.

However, not everyone is dismissive of growth sectors. “We have a favorable outlook on technology,” says Mike Barclay, lead manager of the Columbia Dividend Income Fund at Columbia Threadneedle Investments in Boston. “It’s a long-term growth sector, and companies have been increasingly focused on returning capital to shareholders via dividends.”

Many tech companies, he says, have strong free cash flow, attractive free-cash-flow margins, low payout ratios, and strong underlying fundamentals—factors which “support higher dividend growth in the long term,” he says. “Stocks that can consistently grow dividends over time typically outperform bond proxies like utilities,” he explains.

Growth Potential
Other sectors enjoy growth potential as well, according to advocates. “Sectors that have been punished in a narrow and momentum-led market will outperform,” says Matthew Wittmer, a portfolio manager at Allspring Global Investments in Minneapolis. “Specifically, we find compelling value in financials, industrials and energy.”

Companies in these sectors, he explains, have been demonstrating long-term fiscal discipline. They are especially attractive now, he says, for their “total return potential,” which he defines as their ability to pay a sustained and increasing dividend on top of the likelihood that they will return capital to investors through stock buybacks.

Yet buybacks aren’t attractive for all dividend investors. “Buybacks suggest a company’s good times were yesterday,” says Simeon Hyman, global investment strategist at ProShare Advisors in Demarest, N.J. “Dividend increases indicate a company’s confidence in the future.”

Jeffrey Buchbinder, chief equity strategist at LPL Financial in Needham, Mass., says, “Dividend growth [is] a better opportunity for earnings-driven appreciation in the coming year than bond-proxy sectors like utilities.”

Even if interest rates fall in 2024, he says, utilities “would likely be a strong performer after lagging so much this year, but may still have a hard time keeping up with the big growth sectors, [which have] the most earnings growth potential.”

Valuation Matters
But rising dividends may not be enough to interest some portfolio managers. “Dividend growth alone is not the only reason we purchase a stock,” says Pranay Laharia, a manager at Barrow Hanley Global Investors in Dallas who works with the firm’s dividend-focused value strategy. “Valuation is a key determinant to the long-term performance.”

Value stocks, he says, are currently at a “historically wide valuation discount” to growth stocks. “The time is ripe for value to start outperforming growth.”

Discounted valuations matter to many others as well. “Healthcare, specific financials, industrials and consumer discretionary stocks that grow their dividends offer investors excellent value at current levels,” says Bob Kalman, a senior portfolio manager at Miramar Capital in Northbrook, Ill.

Nevertheless, he recommends mixing high and low dividend payers. “A combination of lower dividend, higher growth stocks and higher dividend issues [can] create a portfolio that balances both income and growth,” he says.

Interest Rates
The effect of high interest rates on dividend-paying stocks is another source of some disagreement among investors. “When competing asset classes such as bonds are paying competitive yields, many investors may choose the ‘safer’ option of bonds,” says O. Emerson Ham III, a senior partner at Sound View Wealth Advisors in Savannah, Ga. “Bonds have gotten to the point where their yields are competitive even on a tax-adjusted basis.”

On the other hand, wealthy investors often prefer dividend-paying stocks to bonds, since bond payouts are taxed as ordinary income while most stock dividends are “qualified” for the lower long-term capital gains tax rate. (To be qualified, the stock must be owned for a period of time and can’t be a holding in a pass-through company.)

Another consideration, however, is that high interest rates have increased borrowing costs, making it “tougher for companies to borrow” and reward shareholders, notes Gary Schwartz, president of Madison Planning Group in White Plains, N.Y.

International Markets
Many investors looking for higher dividends look overseas, since the yields in international markets are more attractive. 

LPL’s Buchbinder favors Japan, “where dividends have started to increase as companies focus more on returning capital to shareholders,” he says.

Some U.S. investors are looking north. “The Canadian market has shown more growth in dividends than many other regions, while also having a relatively stable currency,” says Sam Burns, chief strategist at Mill Street Research in Sherborn, Mass. “It may be worth looking at some of the Canadian dividend-paying stocks.”

There are risks in going overseas for dividends, though. “There’s currency risk,” says Schwartz, since dividends paid in a local currency can lose value against U.S. dollars. What’s more, he says, any gains from international securities may be subject to double taxation—in both the U.S. and the home country.