What it means
These are typically large, mature businesses with predictable demand, such as utilities, water companies, basic food producers and some established consumer brands. Their profits do not change much from year to year, so they can afford to pay out a good share of earnings as dividends.
The share price tends to move less than the wider market, in good times and bad. The label is old-fashioned and a little uncomfortable, but it carries a useful idea.
Some investors, such as retirees, charities and family trusts, need cash income more than they need rapid growth. For them, a dependable dividend and a stable price matter more than a chance of doubling their money.
Analysts use a few checks to decide whether a stock belongs in this group. They look for a long record of paying dividends, a modest payout ratio (the share of profit paid out as dividends), low debt and steady cash flow.
A high yield on its own is not enough, because a very high yield can signal that the market expects the dividend to be cut. Non-finance professionals meet this idea when a pension scheme, endowment or family office describes its investment policy as "defensive" or "income focused".
These stocks are designed to hold their value in a downturn, but they tend to lag when markets surge. They are also sensitive to interest rates, because rising rates make bonds more attractive compared with dividend shares.
No stock is risk free, and the widow and orphan label does not guarantee safety. Companies once seen as untouchable have cut dividends after regulation changed, debt rose or a product became obsolete.
Spreading holdings across several sectors is wiser than relying on a single "safe" name.
In practice
Real-world examples.
Example
A retired teacher holds shares in an electricity utility and a household goods company, using the quarterly dividends to cover living costs. The share prices move little from year to year, so she does not need to sell at a bad moment to pay bills.
Example
A charitable foundation's investment committee sets a rule that 40% of its portfolio must be in stable, dividend-paying companies. The dividends fund the charity's annual grants, and the committee reviews the dividend cover each quarter.
Example
A fund manager moves part of a portfolio into consumer staples and water utilities after a long market rally. The aim is to protect clients' gains, accepting that these holdings will probably lag if the market keeps rising.
Formula
Calculation
Dividend yield = Annual dividend per share / Share price x 100
Payout ratio = Dividends per share / Earnings per share x 100
Suppose a regulated water company pays $3.00 per share in annual dividends, earns $4.50 per share and trades at $75. The dividend yield is 3.00 / 75 x 100 = 4%. The payout ratio is 3.00 / 4.50 x 100 = 66.7%, which leaves about one third of profit for reinvestment. An investor holding 1,000 shares would receive 1,000 x 3.00 = $3,000 a year in dividends.Case study
Seen in the real world.
Meridian Family Trust is a fictional trust set up to support three elderly beneficiaries. In this illustrative example, the trustee held $2,000,000 of shares, and the beneficiaries needed about $80,000 a year in income. The trustee built a portfolio of stable dividend payers averaging a 4% yield, which produced $80,000 without any need to sell shares.
When the wider market fell sharply one year, the portfolio dropped by less than the market and the dividends continued. The next year one of the holdings cut its dividend after taking on heavy debt, which reminded the trustee that the label is not a guarantee. The trustee then added a rule to review payout ratios and debt levels every six months.
Watch out
Common mistakes.
- Chasing the highest dividend yield, when an unusually high yield can be a warning that the dividend is about to be cut.
- Believing that a widow and orphan stock cannot lose money, when its price can still fall and its dividend can still be reduced.
- Holding only this type of stock for decades, which can leave a portfolio with too little growth to keep up with rising prices.
Questions
People also ask.
Why are utilities often called widow and orphan stocks?
Utilities provide services people need in any economy, so their earnings are steady and they have a tradition of paying regular dividends.
Do these stocks suit young investors?
Often less so, because younger investors can usually accept more risk for higher long-term growth, though some still hold them for balance.
How do interest rates affect them?
When interest rates rise, safer bonds pay more, so investors may sell dividend stocks and push their prices down.
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