Dividend Achievers: Seeking Total Return with Dividend Stocks

You’d be hard-pressed nowadays to find anyone with a muted view of dividend stocks after the past decade’s performance.Consider the returns produced by the Mergent U.S. Broad Dividend Achievers Index versus the S&P 500. An investment of $10,000 on March 31, 2000, in the Dividend Achievers Index would have been worth $12,144 on March 31, 2010, while the same investment in the S&P 500 would have been worth $9,119. The Dividend Achievers Index has also shown less volatility, as measured by the return’s standard deviation, than the S&P 500.

The current yields on fixed-income investments also make dividends relatively more attractive. Money-market funds’ yields are barely above zero. According to Bankrate.com, six-month certificate of deposit (CDs) yields are under 0.90 percent (as of mid-July 2010). One-year CD-rates average 1.34 percent and five-year CDs pay only 2.78 percent.

Yields on Treasuries are also low. The yield on two-year notes is below 0.70 percent, 10-year notes pay roughly 3 percent, and 30-year bonds have yields around 4 percent. Bond investors also face the risk that at some point the Fed will begin raising rates, which will reduce bond prices and total returns.

In contrast, companies have been boosting dividend payouts in 2010. Consider these statistics for the first half of the year, as reported on June 26 in the Wall Street Journal:

• The S&P 500 had a dividend yield of roughly 2 percent,
• There were over 130 dividend initiations or increases among S&P 500 companies, and
• S&P 500 non-financial companies were sitting on a record $837 billion in cash at the end of 2010′s first quarter, an ample reservoir for dividend payments.

There is a strong case for seeking out reliable dividends, especially after a careful screening process to identify attractive and reliable dividend stocks.

The Broad Dividend Achievers Index is composed of companies that are incorporated in the United States or its territories, trade on the NYSE, Nasdaq or Amex, and have increased annual regular dividend payments for the last 10 or more consecutive years. In addition, Indxis Inc., the index-services unit of Mergent Inc., requires that a company’s average daily cash balances (i.e., liquidity) exceed $500,000 per day in November and December prior to the annual reconstitution date on the last trading date in January.

The index is reconstituted annually on the last trading date in January. The weight of each company will float between reconstitution and rebalance dates; that means it is possible for a company to weigh more than 5 percent between these periods. The index is rebalanced quarterly on the last trading date in April, July and October.

Mergent has been identifying these strong dividend-paying companies for more than 25 years. Dividend Achievers are typically companies with strong cash reserves, a solid balance sheet and a proven record of consistent earnings growth. The index is dynamic and is reconstituted each year to reflect changes in the component stocks.

In 2009, 89 companies were removed from the Broad Dividend Achievers Index, and 18 new companies were added. Companies classified as financial, real estate or insurance accounted for nearly 75 percent of the deletions.

“As you would expect, over time, the large financials have gone out,” says William H. Rogers, director, Global Index Development for Mergent. However, Rogers notes, that wasn’t true with smaller financial companies or the main industrial companies.

The index is an exclusive club of high-quality businesses: Just over 7.3 percent of 3,700-plus North American-listed dividend paying common stocks are listed as Dividend Achievers. These stocks represent seven industry sectors and more than 33 industries. The companies’ financial stability, as represented by their ability to pay dividends, enhances their stocks’ attractiveness.

The Corporate Perspective

A business that’s generating excess cash flow can use those funds in several ways: invest in the business, make acquisitions, reduce debt levels, buy back stock, pay dividends and so on. Dividends are not the default choice, because the board must approve the payouts versus using the cash for other purposes. So why do firms pay dividends?

StanCorp Financial Group Inc. (SFG) in Portland, Ore., is included in the Dividend Achievers index. Floyd Chadee, chief financial officer for StanCorp Financial Group, says that the company’s focus is on delivering value to shareholders. That focus can lead to several possible uses of excess cash flow.

The first priority is to reinvest in the business, Chadee says, so it can continue to grow. Another option is to seek strategic mergers and acquisitions in order to acquire capabilities that will drive shareholder return. However, Chadee points out, those opportunities are not always available.

The next option is to return excess funds to shareholders. “We return money to shareholders through two mechanisms,” explains Chadee. “We do share repurchases that vary depending on where the stock price is trading and what the overall economy is doing. Another thing we’ve always focused on is paying that steady dividend back to our shareholders and having that dividend grow systematically over time.”

The company’s consistent and systematically increasing dividend is more than just a payback, says Chadee: It’s also a signal to investors that management is running the company conservatively and is confident about its outlook. “(One method for) signaling to shareholders the confidence that we have for the continued success of StanCorp over the long term is having a very stable dividend policy,” he says.

Plains All America Pipeline LP (PAA) has also produced solid results for investors. Mergent reports that PAA has produced 8.6 percent annual distribution growth for the past 10 years. (As a partnership, the company pays out distributions, not dividends, to its limited partner investors.)

According to Roy Lamoreaux, PAA’s director of investor relations, the company does not have a set policy for growing distributions, although management is targeting average annual growth in the 3-5 percent range with upside potential through large acquisitions.