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Dividend stocks are reliable, consistent generators of cash flow that pay much more income than the average stock and are generally considered conservative, solid investments.
However, if you invested in only dividend stocks in 2024, your portfolio likely greatly underperformed the broad S&P 500 stock market index. In fact, the S&P 500 more than tripled the return of the S&P Dividend Aristocrats Index, posting a 23% gain versus just 6.72% for the dividend index.
So why would an investor want to own shares of this underperforming index in 2025? Read on to find out.
Also see some blue chip stocks with high dividend yields for retirees.
The S&P 500 Carries a High Valuation
After the S&P 500 gaining more than 20% for back-to-back years, there’s no denying that it is fully valued. Its current price-to-earnings (P/E) ratio is more than 30, which is very high on a historical basis.
Technology stocks, which are the single biggest contributor to S&P 500 returns, are even more fully valued, trading at about 38 times earnings. Meanwhile, healthcare stocks, financials and utilities — which are more value-oriented, dividend-paying sectors of the market — sport a much more reasonable P/E of 18, per Zacks Investment Management.
According to BMO Capital, stocks generally underperform in the third year of a bull market, at least when compared with the first two years. This may prove particularly true in 2025, after such a strong market rally in 2023 and 2024.
In 2025, some investors might choose to cash in on some of their gains over the past two years and reallocate that money into underperforming sectors, like dividend stocks.
Interest Rates May Fall
Interest rates were pushed higher in 2023 as the Fed fought its battle with inflation, but that’s a war that seems to be over. Inflation has fallen to levels near the Fed’s 2% annual target, triggering cuts to the federal funds rate that are anticipated to continue in 2025.
Why does this matter? In a falling interest rate environment, investments that pay higher yields draw more investor attention. When a government-backed investment like a Treasury bill pays a 4% yield, a stock with a 3% dividend yield might not be attractive to income-oriented investors. But if rates on T-bills fall to, say, 1%, then a 3%-yielding dividend suddenly translates to triple the income while still offering the potential for capital appreciation.
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Yields on S&P 500 Stocks Are Historically Low
When stock prices rise, dividend yields fall. After back-to-back years with double-digit gains in the S&P 500, yields paid by S&P 500 companies have fallen to 1.3%, a relatively low level historically speaking. Meanwhile, the dividend yield of the S&P 500 Dividend Aristocrats Index is about 2.06%.
While dividends tend to rise over time, they often don’t keep up with stock prices, resulting in declining yields. For example, if a company raises its dividend by 10% but its stock price jumps by 20%, its yield will still fall. This is part of the reason there is such a disparity between the income paid by the broad S&P 500 and the narrower Dividend Aristocrats Index.
Investors looking to pick up extra income in 2025 might start buying more dividend stocks, helping to prop up prices.
Dividend Aristocrats Are Defensive
Although dividend stocks don’t always keep up with highfliers when the market is rocketing higher, the opposite is often true during market declines. Stocks with high multiples are often the ones that fall precipitously in price, while more defensive stocks, like those paying dividends, tend to hold up better.
If you’re of the belief that stocks might need a breather after generating huge gains the past two years — but you still want to remain invested — it might make sense to consider dividend stocks in 2025.
If the S&P 500 continues to march upward in a straight line in 2025, dividend stocks might again underperform on a relative basis. But if interest rates fall, the market has an overdue correction or investors simply begin rotating from growth stocks into value stocks, dividend stocks could shine.
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