If your clients’ stock portfolios aren’t earning their desired returns, it might be time to start focusing on dividends. Consider this statistic: between 1999 and 2007, the S&P 500′s had a nominal annual return of 1.5 percent. Capital gains contributed zero to that result; reinvested dividends generated the entire result.
Josh Peters, CFA, is an equities strategist and editor of Morningstar’s Dividend Investor newsletter and author of The Ultimate Dividend Playbook. He believes interest in dividends has been growing for a while. “The resurgence of interest in dividends really dates back to the last bear market, because you had a couple of things happen at once,” he says. “One was that the stock market stopped going up 20 percent a year like clockwork. And all of a sudden, especially in a down market, the idea of getting a cash return that is always positive from the stocks you own becomes a lot more attractive by comparison when you can’t rely on those capital gains anymore.”
The reduction in the tax rate on dividends was another positive factor for them; additionally, companies began re-examining their dividend policies. Peters notes that some companies that had never paid dividends — even in the technology sector, like Microsoft — started paying dividends for the first time. The result, he says, was a “resurgence of interest on the part of both shareholders and companies.”
Mergent’s Dividend Achievers Based in New York City and Charlotte, N.C., Mergent Inc. has been collecting and delivering high-quality financial information since 1900. The company’s databases include key financial, fundamental and descriptive material for more than 15,000 U.S. public companies and another 20,000 companies listed in 100 foreign countries. Companies that have had a stellar performance — based on the number of consecutive years they have paid increasing dividends — and featured in this issue of Research are:
Bemis Co.s (BMS): 24 years
BB&T Corp. (BBT): 36 years
Cedar Fair L.P. (FUN): 20 years
Corporate Office Properties Trust (OFC): 10 years
General Electric Co. (GE): 32 years
Kimco Realty Corp. (KIM): 15 years
Lexington Realty Trust (LXP): 13 years
MDU Resources Group Inc. (MDU): 17 years
MGE Energy Inc. (MGEE): 32 years
National Retail Properties Inc. (NNN): 18 years
Procter & Gamble Co. (PG): 54 years
ProLogis (PLD): 13 years
RPM International Inc. (RPM): 34 years
TEPPCO Partners L.P. (TPP): 15 years
WGL Holdings Inc. (WGL): 31 years
Source: Mergent, 2008
Making the GradeMergent’s Dividend Achiever Indices identify many of the top dividend-paying companies. The indexes began in 1979, when an analyst at Moody’s Investor Services, Mergent’s predecessor company, developed an investment methodology centered on dividends. The initial criteria identified companies that had paid increasing, regular dividends for a minimum of ten consecutive years. There were additional hurdles, including asset size, revenue, profit and liquidity. Companies that met the criteria were called dividend achievers, says Mergent President Bob Andrialis. “So the list was born in 1979, and for 20-some-odd years, it resulted in an annual handbook of dividend achievers that went through this screening process,” he says.
Andrialis had run Standard & Poor’s index business in the 1980s. He suspected that if Mergent back-tested the results of the Achievers index historically, the total returns would fare well versus the S&P 500 benchmark with lower volatility. His hunch proved correct, and Mergent created an index unit that now licenses multiple dividend achiever indexes.
Mergent reconstitutes the Broad Dividend Achievers roster each January, and the firm tries to make as few changes as possible to minimize turnover in the roster, which includes 319 companies. “During the course of the year, we will only delete companies that are no longer viable, for whatever reason, through generally a corporate action or a merger acquisition,” he says.
The Broad Dividend Achievers Index has performed well versus the S&P 500 index, says Andrialis. Over long periods of time — a minimum of ten years — the Dividend Achievers Index generally outperforms the S&P 500 index while producing lower volatility. The reason for that, he says, is that there are virtually no tech stocks in Mergent’s index. “IBM is in it, but no real tech stocks like Microsoft and so forth,” he says. “So the volatility component is gone. The way we like to categorize the opportunity for investors or licensees is you get more for less: a higher total return, generally based upon back-tested results, with lower volatility.”
Andrialis notes that advisors can choose from a wide range of dividend-focused investments for clients. “There are many dividend-focused ETFs and funds out there, sliced and diced every which way, from a broad market dividend play to very specific sector plays and utilities,” he says. “It’s financials, combinations of those, and split geographically also. So not only do you have the sector focus, but you have a sector focus by geography, too.”
Reduced income tax rates have helped spur investor interest in dividends; market volatility did too. “The reasons why dividend products took off — and I’m speaking specifically in the ETF product space five years ago — was really the twin-fold issues of a lower tax on dividends down to 15 percent, combined with the chaotic stock market from the residue of the Internet bubble,” says Andrialis. “People were looking for quality investments, and investors, both institutional and retail, suddenly realized that, dividend-paying companies give you a certain level of guarantee with the yield plus the potential for price appreciation.”
A Half-Century of IncreasesConsumers recognize Cincinnati, Ohio-based Procter & Gamble Co. (PG) as one of the best-known U.S. companies, but investors also recognize the company’s strong financial performance. Over the last six fiscal years, P&G’s EPS compound average growth rate has been 13 percent, and the company estimates EPS growth of 14 to 15 percent for the current fiscal year.
The company’s dividend performance has been stellar. P&G has been paying a dividend to shareholders without interruption since incorporation in 1890, and fiscal year 2008 will mark another 50-plus consecutive fiscal year in which P&G has increased its annual dividend. Over those 50-plus years, the dividend per share has increased at a compound annual rate of nearly 10 percent, and in April, P&G raised its quarterly dividend by 14 percent, from $0.35 per share to $0.40 per share.
These dividends have been an important component in P&G shareholders’ total returns. From April 30, 2003 to April 30, 2008, investors in P&G stock earned a 65 percent total return on their investment. Of that 65 percent return, over 20 percent of it — nearly 14 percentage points — came from dividends and reinvested dividends.
P&G does not have a specific policy regarding dividend payments, according to Jon Moeller, vice-president and treasurer. However, the board does target a payout of about 40 to 45 percent of net earnings. “We know our shareholders appreciate the consistency and predictability of our dividend payments,” says Moeller.
Retail investors hold 38 percent of P&G’s common stock — one of the highest percentages of all U.S. listed companies — and 82 percent of the investors with direct investment accounts have chosen to automatically reinvest dividends. For investors seeking income and growth potential, P&G is worth considering. “With our current dividend yield at about 2.4 percent and given the current yield on other investment alternatives, we expect income-oriented investors — both retail and institutional — may be more attracted to P&G,” says Moeller.
A Quarter-Century of PayoutsBemis Company (BMS), headquartered in Neenah, Wis., is the leading flexible packaging company in North and South America and a major manufacturer of pressure-sensitive materials for global markets. Over the past ten years, sales have grown at a 6.6 percent average annual rate. Bemis also sells products into the food and consumer-product markets and expects those markets to provide opportunities for 6 to 8 percent annual sales growth over the long term. EPS has grown at a 6.4 percent average annual rate over the same ten-year period, excluding the impact of two restructuring programs in 2003 and 2006.
Bemis has a solid dividend history. The company has paid an annual dividend since 1922 and increased its dividend for more than 20 years. “Our dividend program has always been an important component of our shareholders’ investment return,” says Melanie Miller, vice president and treasurer. “During cycles of lower stock prices, the dividend program becomes a greater portion of the shareholders’ total return. Recent changes in tax laws have made dividend programs even more popular over the past few years, so our long history of payments and increases sets us apart from others in the market.”
Bemis’ board of directors has a stated objective of maintaining a dividend payout ratio between 35 percent and 45 percent over the long term. While there is no particular policy with regard to dividend growth, Miller says, the board appreciates the significance of its record of 25 years of consecutive dividend increases. Retail investors hold about 15 percent of the company’s outstanding stock, and Miller believes the current economic environment will continue to spur investor interest in the stock. “During times when the economy is struggling, Bemis’ exposure to food and consumer product markets historically provides a level of stability to our business,” she says. “We generally have a healthy level of interest from income-oriented investors, but during periods of low interest rates and low yields on income investments, we often receive new interest from investors looking for a more reliable return on their investment.”
Looking AheadThe outlook for dividends is favorable. The first wave of Baby Boomers is entering retirement, and those investors will be seeking income that can keep up with inflation, experts say. Morningstar’s Peters believes that group will make its preferences known in the market.
“With so many more retirees looking to help fund their retirement with dividends, they will favor the companies that pay out good dividends and offer good yields and consistent growth,” he says. “That will send a signal to the marketplace that if you have the ability to pay a bigger dividend, then you probably should. And I think that you’re going to see payout ratios rise in order to meet that need that investors have for more consistent income.”
Ed McCarthy, CFP, is a Rhode Island-based freelance writer and photographer.