The Dividend Play: High Growth vs. High Yield

The Dividend Play for a Lifetime

By Jim Royal | More Articles 
July 28, 2010 | Comments (2)

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Last week I highlighted Yum! Brands (NYSE: YUM) as the best China play that wasn't Chinese. As the company behind such brands as KFC and Taco Bell, Yum! offers a compelling prospect for gain. McDonald's (NYSE: MCD)also allows dividend investors to reap payouts for a lifetime, and has a few less-obvious catalysts up its sleeve to unlock value.

High growth vs. high yield
Over the years, McDonald's operational performance has been exceptional, leading to its ability to pay and increase dividends for decades. The restaurant titan currently yields 3.1%, or $2.20 per share. That dividend has more than tripled over the past five years. Nice if you owned the stock since then, I hear you grumble. As a dividend investor, you need to consider how your company might increase its payouts in the future. Knowing the dividend growth rate is as important as knowing the dividend.

Consider the companies in the following table:

Company	Dividend Yield	5-Year Dividend Growth Rate
McDonald's	3.1%	31.3%
Procter & Gamble (NYSE: PG)	3.1%	11.9%
Frontier Communications (NYSE: FTR)	9.7%	0.0%
Annaly Capital (NYSE: NLY)	15.2%	6.9%

Source: Capital IQ.

While McDonald's and Procter & Gamble offer lower yields, they also have the ability to raise their dividends because of their strong consumer franchises. In fact, it's difficult to think of better consumer companies.

On the other hand, both Frontier and Annaly are less able to sustainably deliver dividend growth. While their yields are both sizable, the prospects for future gains are limited. Frontier operates in the declining fixed-line telecom space, and just cut its payout as it integrates some rural operations recently acquired from Verizon.

Meanwhile, Annaly has been able to increase its yield because net interest margin has increased as interest rates dredged the bottom. While Annaly is a nice play in disinflationary times, interest rates won't remain low forever, so there's likely to be a hiccup in its dividend at some point. Those criticisms, though, don't mean either company isn't worth owning -- I own both -- but rather a reminder that you need to know the sustainability of your dividends. Blending high payouts with high dividend growers could make a lot of sense. (I also own Procter & Gamble.)

McDonald's occupies something of a middle ground, and its recent massive increase in its payout is just the beginning. There are good signs that the company has plenty more in store.

Two hidden dividend sources
McDonald's has indicated that for the future it intends to pay out all its free cash flow. Now, some of that cash will go to repurchase shares. In September 2009, McDonald's authorized a $10 billion repurchase plan, and the company has wasted no time in snapping up shares. It bought back about $1 billion in shares in the recent quarter, and nearly $480 million the quarter before that.

But the rest of that cash looks earmarked for dividend increases, which could be very significant.

McDonald's also has at least two other potential opportunities to unlock cash. The company has been undergoing significant refranchising, selling off its company-operated stores to franchisors, and it now operates just 19% of its locations. That's great news, because franchise fees allow McDonald's to realize a better-than-80% margin on franchised stores. In contrast, its company-operated stores have less than a 20% operating margin. By refranchising more stores, McDonald's has been increasing its margins and freeing capital tied up in its stores, even though refranchising makes revenue growth look sluggish.

OK, McDonald's is a mature franchise, even if it does have a few growth areas left, such as China. So McDonald's can't post the type of stellar top-line numbers that quickly growingChipotle (NYSE: CMG) and Buffalo Wild Wings (Nasdaq: BWLD) are able to. Those companies can take advantage of store build-out and increasing efficiency to grow margins, which is why McDonald's spun off Chipotle more than four years ago so that the market would appreciate this distinction. Still, according to perhaps the most honest gauge of retail -- same-store sales -- McDonald's is truly holding its own.

The second hidden store of value is in McDonald's real estate holdings. Even as the company sells off franchises, it maintains the rights to most of its land and buildings. Some of that real estate is in prime locations and has been sitting on the company's books at cost for decades.

The mechanism that Mickey D's might use to unlock that value is unclear, but the value is certainly there. And given how CEO Jim Skinner is pulling out all the stops to make the company a more efficient user of capital, it won't be surprising if he gets that value back to shareholders somehow. I don't factor that into my valuation below, but it offers some potential upside nonetheless.

An apple pie to go
A quick dividend discount valuation suggests that McDonald's may be undervalued. Assuming annual dividend growth of 10% in years 1-5, 7% in years 6-10, and a 2% terminal increase, McDonald's shares should be valued at $82. OK, so you don't think McDonald's dividend can grow at 2% for that long? The current price of $70 implies the same growth rates as above, except no dividend increase ever again after year 10. Given the company's willingness to return all its free cash flow, I'm willing to bet that the company can do much better than no dividend growth after year 10. Are you?

http://www.fool.com/investing/dividends-income/2010/07/28/the-dividend-play-for-a-lifetime.aspx

A discussion on Dividend

Dividend discussion, Dec. 6, 2002

GEOFF COLVIN: Today’s news from Washingtonhas got investors focusing on dividends like they haven’t in a very long time. To get us up to speed – fast – we’ve got a couple of experts on the subject. James Bianco is president of Bianco Research in Chicago. He’s done some fascinating research on when dividends are and are not good for investors. Gail Dudack is chief investment strategist at Sungard Institutional Brokerage in New York City, and she’s been arguing for months that dividend-paying stocks are the place to be. And so far this year she has been very right. Jim and Gail, thanks so much for being with us.

GAIL DUDACK: Great to be here.

COLVIN: Gail, forgetting about whether there’s a change in the tax on dividends, you’ve been arguing for a long time that stocks that pay dividends are the place to invest. How come?

DUDACK: There’s a lot of reasons, but there’s one simple one for the current environment, which is we’re going to be in a slower growth environment, in terms of GDP growth, because of all the debt load. And if that’s true, then earnings will be harder to come by, and if that’s true, they’ll probably grow maybe 5 to 7 percent. If you can get a 3 percent dividend yield in your portfolio, you’re halfway there. You’re likely to outperform.

COLVIN: But you know the argument against dividends, which is that if the companies just kept the money, reinvested it, they could make the stock price go up more, and investors wouldn’t be taxed when they get the dividends. You don’t buy it?

DUDACK: I don’t buy that, because if you’re in a slow-growth environment, there are few places you can get that required rate of return. So companies are buying back their own shares. However, that’s been kind of the spin of the ‘90s, because what did all those share buy backs bring investors in the last few years? Very little. Wouldn’t they have rather had the check in the mail than those stock repurchases? I think so.

COLVIN: Especially over the past 2 ½ or 3 years, they would for sure. Jim, you’ve done some looking into when dividend-paying stocks have been a good investment and when they haven’t. And what did you find?

JAMES BIANCO: What we found is that dividend-paying stocks is an investment theme that seems to work well with the direction of the market.

COLVIN: Meaning?

BIANCO: Meaning that when the stock market goes up, non-dividend-paying stocks do better; when the stock market goes down, dividend-paying stocks do better. So one of the over-arching themes in whether or not you want to invest in dividends is your belief in which way the market’s going to go. If it’s going to go down, you want to invest in dividend stocks; if it’s going to go up, you don’t want to invest in dividend stocks.

COLVIN: And what do you believe?

BIANCO: I think that after 2 ½ years, the market has found some kind of an important low in October. I think it’s going to rally for the next several months, maybe a year. Maybe it’s not going to make a new high. I doubt it’s even going to make halfway towards erasing the losses it had, maybe get to S&P 1200. And if that’s true and the market does do better for the next several months, I think that non-dividend-paying stocks are going to lead that charge.

COLVIN: Okay. Interesting, because it’s not quite the same as what Gail has been saying. Let’s take a step back and look at the longer term, the bigger picture. Dividends have really been going out of fashion for the past 20 years, right?

DUDACK: That’s true.

COLVIN: And I think we have some information on this showing that the number of companies paying dividends has decreased from almost all of them in 1980, 93.8%, paying a pretty fat yield at that time, 5.9, till today only 70% are paying dividends, and the yield is tiny, 1.6%

DUDACK: Historic low.

COLVIN: Historic low. Is that an opportunity?

DUDACK: It’s an opportunity for companies to start picking up their dividends and for investors to start looking for some. I think one of the most important points here is that investors understand that stocks are the best performing asset class, but they don’t understand why. It’s because they have capital gains and dividends. And so the aftermath of the ‘90s shows that stocks don’t always perform. In fact, in the bear market the high-yielding stocks are the best performers.

COLVIN: Well, and in fact we can see that in a graphic we have also which says that – I think this is year-to-date – so far companies that didn’t pay dividends declined much further than companies that did pay dividends. And, Jim, that’s consistent with your observation over a longer period of time.

BIANCO: That is true. And if you actually were to break down this year’s activity between dividend and non-dividend-paying stocks, you’d find that dividend-paying stocks outperformed non-dividend-paying stocks until about August of this year, and then they started to kind of perform in line. And since the October low, they’ve been really outperforming. So the non-dividend–paying stocks have been leading the charge for the last two months.

COLVIN: Well, now this really then gets to a bigger question of what you think the big picture of the market’s future is. Jim, you’ve told us. Gail, you were prescient on this fact a few years ago when you said, you turned bearish. You took heat for it. You were right. What do you think now?

DUDACK: Well, I think we’re in the final stages of the bear. The bull, the transition from a bear to a bull does not happen like that. It’s a transition. So I’ve been saying all year that 2002 is the transition from bear to bull. I now think the transition is going to be pushed out into 2003. The reason being earnings were a huge disappointment. And until the momentum improves, we’re still in this process. I think we may retest these lows, and that’s a contrarian view right now.

COLVIN: Yeah, it is indeed. And longer term, Jim, are you optimistic or pessimistic? You’ve spoken only so far about the next year or so.

BIANCO: Yeah, longer term, if you can look out three, four, five years, I’m not that optimistic. I do think that after, like I said, 2 ½ years of going down, we’ve got a period where the market could rally. I believe the rally started in October. But after we go up maybe 20 percent or so over the next year or year and a half, if that pans out, I think the market’s then ready to start back down again and may test the lows.

Is the big bear market that started in 2000 over? No. We’re ready for maybe a cyclical bull market or a cyclical correction that could last many months where the market’s going to rally, and (after) that is where I meant going (back) down again.

COLVIN: Gotcha. Gail, let’s think about finding stocks that pay dividends. There’s still an awful lot of them out there and you want to choose only particular ones. How do you choose them?

DUDACK: Well, I think it’s important to kind of look, to use some filters, to look for dividends that are greater than inflation, because right then you’re going to have, and inflation’s pretty low, let’s say 2 percent. And then to look for stocks that have pay-out ratios, they’re not paying out more than 70 percent of their earnings. And then you want to look for companies that still have improving profit margins. So you’re looking for good companies with above average dividends, the dividend in line with or above the inflation rate.

COLVIN: And when you run these screens, what kind of companies do you end up with?

DUDACK: Well, when I run the screens, at the top, the high-paying dividends are always the ones that you really have to check out very carefully. You get a pretty low number from the S&P really of companies. And then I look for other things that I like. I like to see companies that have increased their dividend every quarter or every year for the last 10 years. That shows to me that they have a very good business plan.

COLVIN: Like who?

DUDACK: Well, there are companies that have done that like Exxon Mobil has done that. They’ve increased their dividend more than the rate of inflation every year. Johnson & Johnson has done that. Kellogg has done that. (My comment: Interestingly, these are in Warren Buffett's portfolio.)

COLVIN: Interesting. Now you mentioned a minute ago those that have really high yields, and those may be more dangerous than they are attractive. What are some of those? I think we have some of them on a graphic also.

DUDACK: I think you have some on a graphic. The one thing I would say is that when you start to get very high dividend yields, it’s probably because the stock price has collapsed because of some event which needs to be checked into. And so you have to be very careful. And you also want to – this is where the screen is important – make sure that their dividend is not more than their earnings. So take a look at that payout ratio.

COLVIN: Interesting. We only have a few seconds left, but I wanted to get one other view, Jim, because I know you have a thought about bonds. We hear a lot of talk. What do you think investors should be doing?

BIANCO: Bonds are at this point in 2002 the opposite of the stock market. They bottomed in yield the same day the stock market bottomed. They should be the opposite of your view. I think the stock market’s going to rally, that means that yields are probably going to head higher.

Bonds should be avoided. If you have the view that the stock market’s going to go down, bonds will probably do very well. So they’re kind of an anti-stock is really what they are, and they should be viewed as that.

COLVIN: Jim and Gail, thanks so much for being with us.

http://www.pbs.org/wsw/tvprogram/dividenddiscussion.html

High Dividend Yields and Superior Returns

Another favourite value-based criterion for choosing stocks is dividend yields.

More recent studies by James O'Shaughnessy have shown that from the period 1951-1996, the 50 highest dividend-yielding stocks had a 1.5% higher annual return among large capitalization stocks.

In another study, a strategy based on the highest yielding stocks in the DJIA outperformed the market.

The correlation between the dividend yield and return can be explained in part by taxes. Stocks with higher dividend yields must offer higher before-tax returns to compensate shareholders for the tax differences.

It should also be noted that most current studies, like O'Shaughnessy's, exclude utility stocks, which as a group have by far the highest dividend yield but have vastly underperformed the market over the past decade.

(Another point to note: for a stock that is paying fixed dividend, the high dividend yield reflects a lower price of the stock and a low dividend yield reflects a higher price of the stock. Therefore, dividend yield fluctuates along a range. Dividend yield can be usefully employed as another tool for valuing the stock.)

Dividends Without Debt

Dividends Without Debt

By JACK HOUGH
An 18% dividend yield is usually a warning sign. It might mean investors have little confidence in a company's ability to preserve its share price and keep making payments. Often, debt adds to the anxiety. Newspaper publisher Gannett pays 18%, but has sinking sales and profits and carries long-term debt of nearly double its stock-market value. Capstead Mortgage pays 21%. Its business of borrowing cheap-to-hold government-sponsored mortgage debt isn't as risky as it sounds, unless financing dries up -- something investors are clearly worried about.
Biovail yields 18% and owes nothing. It, too, has warts. But maybe the stock has gotten cheap enough to make up for them.
Ontario-based Biovail, Canada's largest traded drug company, has focused since the mid-1990s on making alternative versions of existing drugs. But the thinning development pipelines of big drug makers have given Biovail less to work with.
Its biggest hit, Wellbutrin XL, has faced generic competition since late 2006. Ultram ER, a once-daily pain pill released in 2006, hasn't caught on as quickly as hoped. Demand for Zovirax, a herpes cream, and Cardizem LA, a pill for high blood pressure, is cooling, too. Companywide sales are on pace to shrink to $748 million this year and $695 million next year. Shares, which multiplied in price from 50 cents in 1994 to more than $50 in 2001, have since fallen below $9.
Biovail is plowing money into purchasing and developing a new roster of drugs, an effort analysts say won't reverse sales declines for at least two years. The company is still plenty profitable. A drop of 50 cents per share in profit this year and another foreseen for next year of 24 cents will leave 2009 profit of $1.13 a share. That puts the stock at less than eight times earnings. But investors have their pick of low-P/E stocks about now.
If they can rely on pocketing 18% for a few years, though, shares are certainly cheap enough. The company can afford the payments. Even with dwindling drug sales, it will clear enough free cash. What's unknown is whether management will fund its new drug efforts with a dividend trim or with already-budgeted research dollars. Shareholders surely hope for the latter. Few investments reward investors as richly at the moment as cash in the pocket.
For more debt-free companies with big dividends, if not quite double-digit ones, have a look at the list below.

Click on the image to get the full version.

High-yield stocks more appealing now

22-08-2008: High-yield stocks more appealing now

http://www.theedgedaily.com/cms/content.jsp?id=com.tms.cms.article.Article_e5adafa1-cb73c03a-df294000-75281632#

Stock markets worldwide have been, and will probably continue to be, buffeted by a myriad of uncertainties. Questions such as the health of the US economy and troubled financial markets appear unlikely to be answered anytime soon.

Investor confidence is depressed with the limited visibility. The Kuala Lumpur Composite Index has fallen nearly 26% in the year-to-date. Many have sold down their equity holdings and are staying on the sidelines.

Typically, when uncertainties are high, investors lean towards more defensive and stable dividend-paying stocks. And there are a fair number of stocks that pay good dividends, offering yields that exceed bank deposit rates.

Inflationary pressures and demand slowdown will affect company earnings by varying degrees. However, there are still pockets of strength - and some of these companies are paying higher dividends, in line with their earnings growth. Good dividends, in turn, should lend support to their share prices.

CSC Steel has generous dividend policy

Steel companies, for instance, are enjoying robust earnings. CSC Steel Holdings (RM1.36) reported net profit totalling RM73.5 million in the first half of 2008 (1H08), compared with RM79.7 million for the whole of 2007. Sales and earnings are being driven by higher volume and selling prices for its flat steel products, primarily cold rolled coils (CRC).

Outlook for the steel sector remains upbeat for the next one to two years. Despite a slight weakening in prices, few expect a significant correction from prevailing levels - with costlier iron ore, coking coal and energy providing fairly firm floor support.

CSC has a policy to pay out half of annual earnings as dividends. Hence, based on our estimated earnings of 35.2 sen and 37.2 sen per share in 2008-2009, respectively, dividends should rise to about 18-19 sen per share in those two years. That will earn shareholders very attractive gross yields of 13.2%-14%.

CSC's shares are trading at only 3.9 times our estimated earnings in 2008 and well below its latest reported net tangible assets of RM1.94 per share. Such low valuations would limit the stock's downside risks. The stock will trade ex-entitlement for interim dividend of 6.5 sen per share on Aug 27.

Nestle ups dividends in 2008

Consumer companies tend to enjoy more resilient demand and steadier earnings. Hence, they tend to have stable and higher-than-market average dividend payouts. The current downtrend in commodity prices would also bode well for earnings going forward.

Despite rising raw material costs, Nestle's (RM27.25) 1H08 net profit grew nearly 24% year-on-year (y-o-y) to RM176.1 million - on the back of demand increases and stronger exports. The company paid 61.19 sen per share special dividends earlier this year and has proposed another 50 sen per share interim dividends. The entitlement date was fixed for Aug 26. Assuming total dividends of 171.2 sen per share for 2008, shareholders will earn a net yield of 6.3%.

Amway maintains steady dividends

Direct selling company Amway (RM6.85) is also doing pretty well. Net profit was about 24% higher y-o-y in 1H08 at RM42.7 million. The company has been paying dividends very consistently over the years. With minimal capital expenditure required, Amway usually distributes the bulk of earnings back to shareholders.

Dividends are expected to total 61 sen per share in 2008. That translates into gross yield of 8.9%. Its shares are also trading at fairly decent valuations of roughly 12.9 and 12.1 times our estimated earnings of 53 sen and 56.8 sen per share in 2008-2009, respectively.

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.