4 Ways to Play Defense With Dividend Stocks

May 31, 2023

Dividend stocks in industrials, health care, consumer staples and global markets could help your portfolio stay resilient in today’s uncertain environment.

Daniel Skelly

Key Takeaways

  • Amid potentially muted U.S. equity performance, dividend stocks may help boost returns and dampen volatility in a portfolio.
  • Consider actively managed strategies offering exposure to U.S. dividend payers in industrials, health care and consumer staples.
  • International stocks tend to pay higher dividends than their U.S. counterparts and may enhance portfolio diversification. 

The stock market has managed to stay positive for much of this year. However, with interest rates at their highest level in more than a decade and economic growth slowing, not to mention recent turmoil in the banking sector, uncertainty looms large. Additionally, equity valuations are already high relative to earnings—and current earnings estimates may be inflated. As a result, investors may see another drop in the stock market before they can truly declare the bear market over.


Against this backdrop, Morgan Stanley’s Global Investment Office suggests that investors remain defensively positioned and seek out opportunities in select dividend stocks, for two key reasons:


  • Dividends may play a larger role in generating returns. The next several years are likely to be marked by lower equity returns and higher volatility, which could lead dividends to account for a greater portion of total stock market return. From 2013 through 2022, about 17% of the S&P 500 Index’s total return came from dividends. But over a longer horizon, starting from the 1930s, dividends accounted for 37%. The next several years will likely look more like the longer-term picture.
  • Dividend stocks may buffer against market volatility. When a company can reliably pay dividends or even increase them, it likely has a certain level of financial strength and discipline. For investors, this regular income stream can offer some hedge in what continues to be an uncertain stock market. In fact, in 2022, the S&P 500 overall lost about 18%, but the S&P 500 Value Index (which is often used as a proxy for dividend stocks) kept its losses to about 5%, and the S&P 500 High Dividend Index lost about 1%. In the same period, Morgan Stanley’s Dividend Equity model portfolio returned a positive 1.8%.


How to Invest in Dividend Stocks Today

There are several areas of opportunity for active stock pickers to integrate dividend stocks within their portfolio.

  1. 1

    This sector covers a wide range of industries, including manufacturing, distribution, transportation and defense. In particular, we favor defense companies that are likely to benefit from strong cash flows and bipartisan policy support: Mounting geopolitical conflict and aging defense infrastructure spurred Congress to boost defense spending by 10% for 2023, up from an average 3% per year since the 1940s. We expect lawmakers to continue to support increases to the defense budget and believe companies with exposure to high-priority programs, such as aeronautics and space, stand to benefit.


    Additionally, select waste-management businesses may also warrant a closer look, particularly large firms with a full range of offerings that may benefit from sustainability-focused investments in areas like recycling and fleet electrification.

  2. 2
    Health Care:

    This sector offers attractive portfolio-diversification benefits, having outperformed the market by an average of 13 percentage points over the last four recessions. At the same time, exposure to innovative trends like genomics and medical AI may make the sector attractive to investors seeking to play both offense and defense. One defensive area to consider is managed-care organizations that have vertically integrated in recent years to help reduce costs and expand profit margins. Notably, investors’ concerns about government intervention in this industry tend to drive valuations lower in the one to two years leading up to a U.S. presidential election, even as earnings remain resilient. With this pattern playing out today, we see an attractive entry point for investors.  

  3. 3
    Consumer staples:

    This sector can play a valuable role in a defensive investing strategy, offering the potential for stable earnings, growing dividends and lower volatility. There may be particular opportunity today in companies that are able to raise prices without denting sales and that are doubling down on sales-and-marketing investments to help further boost revenues. As consumer companies recover from elevated commodities prices, expect to see improved profit margins for select companies. Consider stocks with attractive valuations and a history of healthy dividend payments. 

  4. 4
    Global dividend payers:

     Looking beyond the U.S., global dividend payers could offer greater portfolio diversification as international equities show continued momentum in recent performance relative to U.S. stocks. What’s more, international stock dividends tend to be higher, given that for many years U.S. companies have instead been prioritizing stock buybacks that help boost share prices.

Be Selective Among Dividend Stocks

Although dividend stocks can help to defensively position your portfolio, it’s important to remember that just because a company pays dividends does not necessarily mean it’s a great investment. Businesses can reduce or eliminate their dividends at any time. Notably, investors may want to avoid the highest-yielding dividend stocks, as that can be a signal of deteriorating financials and potential dividend cuts.


Investors should be selective and look for businesses that have strong management, high dividend-coverage ratios (i.e., a company’s net income divided by the dividend paid to shareholders) and strong free cash flow, as well as a track record of maintaining and even increasing their dividends throughout economic cycles. 

Ask your Morgan Stanley Financial Advisor how your portfolio may benefit from actively-managed exposure to dividend stocks. Learn more in this audiocast. Your Financial Advisor can help you access opportunities to invest in dividend-paying stocks that our strategists believe may generate strong total returns through varied market environments.

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