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

Stable dividend policy is followed by prudent management.

Stable dividend policy is followed by prudent management, as it enhances prestige and credit standing of the company and the shareholders also prefer such a policy, as it leads to stability in market prices of shares. Stable dividend means that a certain minimum amount of dividend is paid regularly. It may also mean that dividend is paid regularly by the company, but the amount or rate of dividend is not fixed. However, the former meaning is more acceptable. The stable dividend may take the following forms:

(1) Fixed Amount of dividend per share.
(2) Fixed Share of Profit (Constant Pay out Ratio).
(3) Fixed Total Amount of dividend.
(4) Fixed Percentage of market price of shares.



Constant Pay-out Ratio




http://www.listedall.com/2010/02/stable-dividend-policy.html

The Power of Increasing Dividends

How can increasing dividends build phenomenal wealth?

By harnessing the power of compound interest...

Reinvested dividends magnify an investment's typical return by making use of the power of compound interest.

Need an example?

Let's look at a traditional savings vehicle which takes advantage of compound interest...

A savings account.

Let's say your savings account pays 2.0% annually on a $34 initial deposit (in a moment, you'll see why I chose $34 as an example). Here's what that looks like...

Now, imagine how much money you would've earned in year ten if the 2.0% rate also increased on an annual basis along with the principal balance...

You would have a lot more. Right?

Well, that's typically what happens when you invest in a great company with consistent and increasing dividend payouts.

Need an example?

Below is a chart of actual dividends paid by PepsiCo, Inc. from 1999 to 2008. $34 would have purchased 1 share of Pepsi (PEP) in 1999 (this is why I used $34 in the savings account example).

In this case, PepsiCo stock is the perfect illustration of the power of compounding dividend returns...

Notice the "dividends paid" figure in year ten?

Also notice the yield in year one is substantially less than the year one savings account rate in the previous example. But the 2% savings account rate doesn't change, while the dividend yield on the initial investment in PepsiCo stock more than triples. By year six, it eclipses the yield on the savings account and keeps growing and growing.

From 1999 to 2008, the effective dividend yield for PepsiCo stock increased on an annualized basis of 13.57%...! That means, on average, your dividend yield just about doubles every five years. Now, imagine if you continue to hold your PepsiCo stock for another ten years while the dividend payments increase and increase and increase...

In the initial years, you do better with a savings account. But in the long term, you do far, far better with a great company's dividends.

That's the power of compound interest, and you can harness and amplify that power by investing in great companies with a history of consistent and increasing dividends.

So if you want to substantially increase your odds of beating the market and building a successful Roth IRA portfolio, find companies with a track record of increasing dividends...


http://www.your-roth-ira.com/dividend-payout-ratio.html

Income investing, especially when coupled with a dividend reinvestment strategy, is an effective way to generate income from and also grow a portfolio.

How to Earn 26.5% on $20,000


Boost Your Income from $1,400 to $5,299 in Just a Few Years

Even the younger generation is paying heed to the wisdom of diversifying with income investments. They are starting to realize that income investing, especially when coupled with a dividend reinvestment strategy, is an effective way to not just generate income from -- but also grow -- a portfolio.


The chart above shows your potential annual income stream assuming a $20,000 initial investment in stocks with an average yield of 7%. Thanks to the power of reinvested dividends and dividend growth, after 10 years your portfolio could be generating $5,299 in annual income -- that's +278.5% more income when compared to an investor who doesn't reinvest. In fact, it could be generating an effective yield of 26.5% based on your initial $20,000 investment.

If you have even a little bit more time on your investment horizon (or more money to invest, or additional dollars to invest each year), then the numbers only get better. And keep in mind that these are conservative estimates.

http://www.streetauthority.com/a/how-earn-265-20000-1029

A Company with Favorable and Continued Dividend Growth

http://seekingalpha.com/article/99644-china-mobile-looks-like-value-smells-like-growth

Dividend Growth Investing: A Look at 10 Year Dividend Growth Rates of some Companies

The screening criteria applied toward the S&P Dividend Aristocrat index was:

1) Current yield of at least 2.50%
2) Dividend payout ratio no higher than 60%
3) Price/Earnings Ratio of not more than 20
4) 25 years or more of consecutive dividend increases


http://www.dividendgrowthinvestor.com/2010/04/16-quality-dividend-stocks-for-long-run.html

High Dividend Payout Ratio = High Earnings Growth Rate (??)

I have always been under the impression that a dividend payout ratio must not be too high because it can limit the ability of the company to grow.  I look for a dividend payout ratios that are at least below 60%, preferably even lower.  I have selected this target because I have believed that the lower payout ratio will provide the company with a sizable chunk of earnings to grow the business and with a lower than 60% dividend payout ratio a company can continue to grow its dividend even during time of economic slowdowns or reduced earnings.

It appears that this theory and fundamental analysis principle has been refuted in a study by Robert D. Arnott and Clifford S. Asness (pdf document). Their theory is that higher dividend payouts actually have lead to higher earnings growth. And with higher earnings growth, share prices tend to go up over time which is better for all of us investors. Let’s have a look at their research and findings.

But First a Definition of the Payout Ratio


The payout ratio is the percentage of a company’s earnings that are paid out as dividends. In a nutshell, the payout ratio provides an idea of how well earnings support the dividend payments. More mature companies tend to have a higher payout ratio.

The crux of the Arnott and Asness research really boils down to one chart. Have a look and it is clear that there is a trend happening here.



As you can see, for a high number of companies, the higher the payout ratio is the better earnings growth the companies experienced. Here are some comments from the authors:

• In general, when starting from very low payout ratios, the equity market has delivered dismal real earnings growth over the next decade; growth has actually fallen 0.4 percent a year on average–ranging from a worst case of truly terrible –3.4 percent compounded annual real earnings for the next 10 years to a best case of only 3.2 percent real growth a year over the next decade. 
• From a starting point of very high payout ratios, the opposite has occurred: strong average real growth (4.2 percent), a worst case of positive 0.6 percent, and a maximum that is a spectacular 11.0 percent real growth a year for 10 years.

So what do we, the average investors do with this data?

My view is that I am going to continue to use my 60% payout ratio benchmark, but will not scoff at a higher dividend payout ratio as quickly. I still believe that it is the average historical payout ratio that an investor must be concerned with – any recent jumps in the payout ratio need to be examined to determine why the change occurred.

http://www.thedividendguyblog.com/high-dividend-payout-ratio-high-earnings-growth-rate/

But, do read the article below which contradicts the above findings.

----

High Yields and Low Payout Ratios

The above post has covered high dividend stocks and the fact that they have been better market performers than low yield stocks. However, it has not been simply buying all the high dividend stocks that has been the most powerful. A study conducted by Credit Suisse Quantitative Equity Research looked at high yields and payout ratios. Their study found that it is high yields coupled with low payout ratios that have provided the best gains over lower yield investing. Although the study used a shorter time frame (1980 – 2006) than many of the other studies we have looked at, the data is pretty clear in its messaging. Take a look at the chart below:



It is interesting to see that the stocks that had a high payout ratio as a whole produced worse gains than the S&P 500, but the stocks that either paid no dividends, had a low yield, or had a high yield did better than the S&P 500. That payout ratio is certainly more important than I thought it was based on this study. A high payout ratio can certain indicate trouble in a company and must be watched closely.

http://www.thedividendguyblog.com/day-5-the-dividend-key-high-yields-and-low-payout-ratios/

Stocks with High Dividend Yields have outperformed in the U.S.

Why are Dividends so Important?
"Dividends have historically accounted for more than half a stock's total return."  Jeremy Siegel, PhD.

Stocks with High Dividend Yields have Substantially Outperformed the S&P 500 for 10 and 20 Year Periods.

Dividends are evidence that a Company is profitable.  Corporations find it difficult to pay out false earnings.

An S&P study shows that stocks that paid dividends outperformed non-payers by 1.9% per year from 1980-2003.

When Dividend is Cut or Omitted?

The Board of Directors proposes that no dividend be paid for the financial year 2009 (0).

http://www.swedbank.com/idc/financialreports/AnnualReports2009/en/Om_Swedbank/Ekonomiskt_sammandrag_2009/ekonomiskt_sammandrag_2009.html

Free cash flow yield trumps dividends as a driver of returns

Managing risk: An emphasis on free cash flow and transparency

As dividend cuts make headlines, it is important to remember that dividend payouts are only the tip of the iceberg when it comes to identifying dividend-paying companies and sizing up dividend risk relative to a company’s total return3 potential. Moreover, in the current environment of rising dividend yields, it’s important to be cautious about “yield chasing”, as some of these yield premiums could be due to precipitous stock price declines instead of bona fide, sustainable growth in the underlying businesses.

Consistent dividends and dividend growth are characteristics of good businesses, but in the view of the management team of the PH&N Dividend Income Fund, other more important factors must be evaluated in tandem. These include strong free cash flow, a solid financial position, and a management team with a record of making intelligent decisions regarding how it deploys free cash.

In an era when corporate earnings can easily be obfuscated by the rotating door of GAAP methodologies4, it is refreshing to be able to rely on a valuation metric that is difficult to manipulate or misrepresent. Free cash flow is one such measure, and it is attractive for its transparency.

Free cash flow is the cash that is left over after a company has made the appropriate allocations to maintain or grow its asset base (working capital and capital expenditures). Essentially, this pool of “free cash” allows a company to pursue shareholder-friendly activities, such as paying dividends, making acquisitions, and paying down outstanding debt.

The chart below was adapted from research conducted by Empirical Research Partners – it depicts relative returns for U.S. large cap stocks sorted by dividend growth, share repurchases, and price/free cash flow over the 35-year period from 1970-2005.



You will notice the following:

• Strategies focused only on dividend growth have only modestly outperformed the S&P 500 Index.
• Companies that pay no dividends at all have the worst return records.
• Strategies focused on price/free cash flow were the most effective at outperforming the S&P 500 Index.

Even in today’s severely compromised market environment, companies are fiercely protective of their free cash flow. Despite the downturn, free cash flow has held up remarkably well due to a couple of factors: a low capital expenditure base and aggressive management of working capital.

https://www.phn.com/Default.aspx?tabid=1103

How Much Stock Dividend Did You Receive in 2009?

While the annual dividend receipt of $5,000 is quite insignificant compared with my portfolio size of over $850,000, bear in mind it only comes from my individual stock holdings, which grew from about $200,000 at the start of the year to about $280,000 by the end of November. The $5,000 dividend payout, therefore, represents about a 2.0% dividend yield for my individual stock holdings.

It is amazing that at one point in November, Bank of America is yielding 6% and Citigroup is yielding 7%. It reminds me of 2002-2004 where I invested in R. J. Reynolds and Altria when they were facing apparently huge litigation risks and yielded over 5%. Am I bottom fishing again?

http://www.pfblog.com/archives/6316_how_much_stock_dividend_did_i_receive_in_2007.shtml

Value investing style drives investors to many companies that pay handsome dividends. Therefore, it is quite useful to ask the question: how much stock dividend did you receive in 2009?

Unlike bond payments which are fixed, stock dividends could be raised

A good starting point for income investors is the S&P Dividend Aristocrats list, which features companies that have increased their annual dividend payments every year for more than 25 consecutive years. Here are the 20 highest yielding stocks in the index, along with their ticker, P/E ratio, dividend yield and dividend payout ratio.



A great idea for income seeking investors is investing in stocks that pay good yields and have consistent dividend payments. With inflation averaging around 3 - 4% per year, your investment in dividend paying stocks would provide you with a source for income that keeps its purchasing power over time, which unlike fixed income securities can also provide you with capital gains. Unlike bond payments which are fixed, stock dividends could be raised and thus provide stockholders with a nice raise for owning the right companies.

http://www.dividendgrowthinvestor.com/2008/06/20-highest-yielding-dividend.html

Total Stock Returns = Fundamental Return + Speculative Return

Over long periods of time, if you take the entire stock market, you would expect the speculative return to be very negligible. This makes a lot of sense, right? In the end, you’ve got to show me the money! And history agrees. Over the last 100 years, the total annualized return for the total U.S. market was 9.6%, and all but 0.1% of that was explained by earning growth and dividends. (See graph below.)





Fundamental Return = Earnings Growth + Dividend Yield

Speculative Return = P/E Ratio Changes

Total Return = Fundamental Return + Speculative Return

What are we buying when we buy a share of a company? Essentially, we are buying a stream of future money. That money is returned to us the form of earnings growth (which increases the share price) and dividends (which goes straight to us as cash).


http://www.mymoneyblog.com/will-future-long-term-stock-returns-be-less-than-8.html

The Little Book of Common Sense Investing by Vanguard founder Jack Bogle

Double Your Dividends by Investing in Foreign Companies

http://www.globaldividends.com/newsletter.asp?d=2010



http://www.investmentadvisor.com/Issues/2007/August%202007/Pages/The-Income-Barista.aspx




http://www.zimbio.com/Stock+Portfolio+Investing/articles/554/Three+useful+dividend+growth+reinvestment

Australian companies usually have high dividend payout ratios and dividend yields.

http://topforeignstocks.com/2009/08/24/top-10-banks-of-australia-by-assets-deposits/

10 by 10: A New Way to Look at Yield and Dividend Growth

Dividend investors often set minimum requirements for an “acceptable” initial dividend yield and/or dividend growth rate when they are considering buying a dividend stock.

Thus one investor might say, “I won’t invest in a dividend stock with a starting yield less than 3%.” Another might say, “I want a minimum 10% per year dividend increase.”

The goal, of course, is to purchase stocks whose yields and dividend growth rates are high enough to make them better bets than safer fixed-income investments like money market accounts, certificates of deposit, and bonds.

The dynamic that determines the goal of “high enough” is how a stock’s initial dividend yield and annual dividend growth rates interact over time. Obviously, a 6% initial yield will require a lower annual growth rate than a 2% initial yield to achieve a given return within a given time. By the same token, a 6% initial yield will get to a given return faster than a 2% initial yield for any given rate of growth.

Most dividend investors have a long-term holding period in mind when they buy dividend stocks. They are not looking to trade them often, but rather to hold them, allowing time for the dividends to increase and compound, until the stock itself becomes a money-generating machine irrespective of the stock’s price fluctuations.

Here is a useful way to look at this: Look for stocks that will achieve a 10% dividend return on your original investment within 10 years’ time. I call this the “10 by 10” approach.

The two 10’s are arbitrary, of course. You can put in any goals you like. I chose 10 and 10 because:
10% is a healthy rate of return, almost equal to the long-term total return of the stock market itself, which most studies show is between 10% and 11%. (Total return includes price appreciation as well as dividend return.)

10 years is a useful time frame for people of most ages. Young people, of course, have a much longer investment timeframe, but nevertheless may consider 10 years long enough to wait for the kind of return they are seeking. Older people—say in their 60’s and 70’s—still often think in terms of timeframes at least as long as 10 years, since just by having lived to their current age, their life expectancy usually is longer than 10 years from right now.

And, of course, 10 is a nice round number. It is easy to think in terms of 10% return and a 10-year timeframe to get a good grasp of the underlying principles.

So the question becomes simple: What initial yields, compounded at what rates of growth, achieve 10% return within 10 years?

The following table answers that question. It shows initial yields (across the top) and annual growth rates (down the side). Where any two values intersect, the table shows how many years it takes to achieve a 10% dividend return. Beneath the table are a few notes on calculation and interpretation.



The faster you hit your 10% dividend return rate goal, the fewer years that your stock choice is subject to prediction risk—that is, the risk that you overestimated its rate of dividend growth. As all dividend investors know, their initial rate of return is fixed at the time of purchase, but the future rate of dividend growth is somewhat speculative. Also, the higher the rate of projected dividend growth, the lower the probability that it will actually be achieved. Getting to your goal in fewer years is generally better all around.


http://www.dividendgrowthinvestor.com/2008/11/10-by-10-new-way-to-look-at-yield-and.html

Global High Dividend Stocks Have Outperformed the Markets

Dow Dividend Yield

The list is ranked based on dividend yield as of Dec. 31, 2009. As you can see, the dividend yield varies from an attractive 5.9% to 0%.

Here's a bar chart showing the dividend yield of the Top 15:

How to Create a Stream of Lasting Dividend Income

Future Dividends Growing at Varying Growth Rates 
(Graphic)





How to Create a Stream of Lasting Dividend Income
Thanks to the power of reinvested dividends and dividend growth.

The power of compounding from Reinvested Dividends

The two charts below show the cumulative return of a dollar for the S&P 500 Index on a price only basis and total return that includes reinvested dividends since 1926. The second chart shows the power of compounding on a percentage basis.