When it comes to consistently rising dividends, execution and excellence are paramount. Though a company might borrow funds to pay for a special one-time dividend, regular dividend payments require a steady stream of free cash flow. Increasing those dividends over time, furthermore, demands growth in free cash flow plus management’s long-term commitment to increasing dividends.
Companies qualifying for the NASDAQ Dividend Achievers indexes have demonstrated their consistent commitment to generating value for shareholders. The indexes started in 1979, when Moody’s Investor Service created a proprietary model designed to identify financially strong dividend-paying companies. Mergent, Inc., acquired the model in 1998, and the indexes became known as the Mergent Dividend Achievers Indexes.
NASDAQ OMX acquired the Dividend Achievers brand from Mergent in late 2012 and added several screening rules to make the indexes more transparent for investors. The Dividend Achievers are now part of the NASDAQ Dividend and Income Index group, but the underlying approach to selecting index components remains the same, according to John L. Jacobs, executive vice president with NASDAQ OMX Group in Rockville, Md.
“We didn’t change the flavor [or] the overall approach that Mergent had to Dividend Achievers, because we think that’s the secret sauce,” says Jacobs. “But what we did do is standardize them to be consistent with NASDAQ’s philosophy of objective, transparent rule-based indexes that we administer on a very consistent basis. So, no surprises.”
Jacobs provides several examples of this standardization. If a company announces it will be involved in a merger, it won’t be included— which avoids its post-merger removal. Bankrupt companies are not included.
NASDAQ also has detailed its policies on when it will rebalance an index and how it will handle stock issuances. For example, if a company declares a large stock split or secondary offering that will change more than 10% of its total shares outstanding, that index will be adjusted immediately. Smaller changes are deferred to the quarterly rebalancing date.
“If it’s smaller than that—routine (cases) where a company changed their total shares outstanding because of an employee stock option exercise or this, that and the other—then we do those on a quarterly basis to coincide with quarterly rebalancing,” says Jacobs.
There are multiple NASDAQ Dividend Achiever indexes, and the index components can overlap to allow for more focused tracking. The Dividend Achievers 50 index, for instance, is comprised of the top 50 securities ranked by yield in the U.S. Broad Dividend Achievers index. (The table to the right shows the currently available indexes and the number of companies in each.)
The indexes are diversified across industries. The composition of the U.S. Broad Dividend Achievers index includes basic materials (3.56% of the index value); consumer goods (21.58%); consumer services (13.36%); financials (5.39%); health care (10.11%); industrials (13.64%); oil and gas (17.20%); technology (5.53%); telecommunications (5.22%) and utilities (4.41%).
Achieving Index Status
The Dividend Achievers is an exclusive club. To qualify, a company must meet multiple requirements, such as dividend payments, listing and liquidity. For the U.S. Broad Dividend Achievers Index, as detailed on the NASDAQ OMX website, the security types eligible include: common stocks, shares or units of beneficial interest, limited partnership interests and shares of limited liability companies.
To be eligible for initial inclusion in the index, a security must have at least 10 consecutive years of increasing annual regular dividends based on pay-date, be incorporated in the United States or certain benefit-driven countries, and have a minimum average daily cash volume of $500,000 in November and December.
NASDAQ reviews the index’s composition annually in January. If a change is required, it becomes effective after the close of trading on the last trade day of that month. Stocks can be removed during the year and replaced.
Other details worth noting:
- The index is rebalanced quarterly with changes to the shares becoming effective after the close of trading on the last trading day in March, June, September and December.
- NASDAQ calculates two versions of the index; the price return version (DAA) does not account for cash dividends; the total return version (DAATR) reinvests cash dividends on the ex-date; and both Indexes reflect extraordinary cash distributions.
The qualification requirements for the International Dividend Achievers Index are similar, but the screens are applied to and adjusted for non-U.S. securities. Eligible securities include ADRs (American depositary receipts), GDRs (global depositary receipts), limited partnership interests, ordinary shares and shares of limited liability companies.
Additional inclusion criteria include:
- Listing on the NASDAQ Stock Market (NASDAQ), the New York Stock Exchange and NYSE MKT;
- The security’s issuer must be incorporated outside of the United States;
- A minimum average daily cash volume of $500,000 in November and December (before the January listing);
- At least five consecutive years of increasing annual regular dividends based on pay-date;
- If an issuer has multiple securities, the security with the highest cash volume will be selected for possible inclusion into the Index;
- The issuer may not have entered into a definitive agreement or other arrangement which would likely result in the security no longer being index eligible;
- The issuer may not currently be in bankruptcy proceedings; and
- A GDR must be listed on the London Stock Exchange and have a U.S. listing on the OTCBB, Pink Sheets or NBB and meet the additional eligibility criteria other than listing market.
Investment managers can license the Dividend Achievers indexes for products such as mutual funds, exchange-traded funds (ETFs), unit investment trusts (UITs), structured products, separately managed accounts (SMAs) and others. As of early July 2013, Dividend Achiever products held approximately $19 billion of investor assets. (The table above lists currently available products based on these indexes.)
The Importance of Dividends
Some investors focus more on dividend-paying stocks when interest rates on fixed-income investments are low or equity markets are unusually volatile. While these are valid motivations, of course, they overlook other features that make dividend-paying stocks attractive as long-term investments in a variety of market environments. As the NASDAQ website notes:
Companies that pay regular dividends tend to be in better financial health and produce sustained earnings and revenue growth.
Dividends help identify well-managed companies; every dividend declaration represents a promise by management and a vote of confidence by the board of directors in the company’s leadership.
Companies that consistently raise their dividend payouts also raise the bar on their own performance expectations.
Shares of dividend-paying companies possess built-in value that makes them generally more resilient in down markets, with solid appreciation potential during earnings-driven market upturns with less price volatility.
Dividends are also a key source of returns historically. In a 2012 paper, “Why Dividends Matter,” Dr. Ian Mortimer and Matthew Page of Guinness Atkinson Funds studied dividends’ contribution to stocks’ total returns. This contribution averaged 52.7% for the decades since the 1940s, with much higher levels — 75%-plus — in the 1940s and 1970s.
The authors note: “What we find more compelling, however, is that the importance of dividends to total returns increases dramatically in low-growth decades — which are defined by some combination of sluggish economic growth, rising inflation, increasing oil prices, and high unemployment. In low growth periods such as the 1940s and 1970s, dividends accounted for over 75% of total returns.”
The two exports also report that dividends’ importance to total return grows with the investor’s holding period. For investors with longer-term perspectives, dividends have been the key driver in returns.
“For an average holding period of one year, dividends accounted for 27% of total returns for the S&P 500 since 1940,” Mortimer and Page explain. “If we increase the holding period to three years, dividends account for 38%; [for] five years it increases to 42%; over a 10-year period, it rises to 48%; and with a 20-year holding period, dividends account for some 60% of total returns.”
Dividends & Markets
Mortimer and Page also see dividends as providing market signals from a company’s management team: “The market sees a long history of dividend payments as establishing a company’s credentials and the management team, making significant cuts by company management more unlikely. That is, dividends are a reflection of the long-term earnings power of a company and are therefore set at a level that is sustainable.”
This belief is shared among leaders of several firms that qualify for Dividend Achiever status. Robert J. Sprowls, president and chief executive officer of American States Water Company in San Dimas, Calif., notes, “Maintaining and growing the dividend signals to shareholders the confidence our management team and board of directors have in the future of the company. Both actions also allow us to share the success of the company with our investors.”
Sprowls adds, “Creating shareholder value is a key driving force behind the business decisions we make. As the company’s earnings have grown, we have continued to grow our dividend. In May 2013, we announced a 14.1% increase in our third-quarter dividend. This is on top of the 26.8% dividend increase in the third quarter of 2012. We are proud of the fact that the company has been able to increase its annual dividend for 59 consecutive years. Our inclusion on the Dividend Achievers list validates our position as one of the strongest dividend paying companies and an attractive investment.”
Benefits for Investors
Frank C. Sullivan, chairman and chief executive officer of RPM International in Medina, Ohio, another Dividend Achiever, emphasizes the value that the firm’s dividend policy has for investors. “We view the cash dividend as an important part of total return to our shareholders, which has outpaced the Standard & Poor’s 500 by 87% over the past 10 years and by 27% over the past five years,” he says. “We also view it as a prominent indicator of our strong cash flow position.
“Lastly, a commitment to an annually growing dividend instills a cash-focused discipline that helps drive consistent performance,” explains Sullivan. “Our last increase of 4.7% on October 4, 2012, which increased the quarterly dividend to $0.225 per share, represented RPM’s 39th consecutive year of increases in the cash dividend. Less than 50 companies out of 19,000 publicly traded businesses have increased their cash dividend for this period of time or longer, and we are proud to be among this elite group.”
Tony Ivins, corporate treasurer of Questar Corporation in Salt Lake City, Utah, expresses similar views on behalf of the company, which is a Dividend Achiever. “Questar’s dividend is an important source of return for investors,” he says.
“Since our restructuring in 2010, Questar’s board of directors has increased the annual dividend by almost 40% and continues to target a 60% dividend-payout ratio,” Ivins explains. “With our earnings growth outlook, we expect our dividend will continue to grow, building on our history of increasing our dividend 41 times over the past 41 years.”
New Investment Options
The hallmark of these Dividend Achiever companies and their peers is consistency. Their management teams recognize the value of dividends to shareholders and as a signal to the market.
Foreign investors also value U.S. Dividend Achiever companies, and NASDAQ is working to expand the index line to attract those investors, says Jacobs. The first products to target this market are aimed at Canadian investors.
“Right now, if you’re a Canadian investor and you want to buy the U.S. Dividend Achievers, that’s fine. Go ahead and buy it,” he shares. “However, you’re at risk now for the Canadian dollar versus U.S. dollar, if you sell in your own account in Canada. So, we created index versions that have a built-in Canadian hedge for the Canadian dollar. The portfolio is 100% hedged, and that makes it much more palatable for a Canadian. And, we can do that obviously in other countries too.”