Looking for strong dividend stocks? Some top fund managers are finding them in an unlikely place: the tech sector.
In his first-quarter letter to shareholders, top fund manager Bill Nygren of Oakmark says that he’s keying on companies that are putting their cash to work.
“Corporations today have unusually strong balance sheets and are generating much more cash than they can profitably reinvest in their own businesses,” Nygren writes. “Unless managements just let the piles of cash keep growing, which is clearly suboptimal, there are only three ways to deploy it: higher dividends, share repurchases and acquisitions. And companies are doing all three.”
Nygren says that most investors don’t focus on those uses of cash. “They assume that EPS growth and dividend growth will mimic organic net income growth and that, when they diverge, it is unsustainable,” he says. “We believe that historically low dividend payout ratios make it likely that dividend growth will exceed EPS growth for years to come.” Last year, he says, the S&P payout ratio was 30%; from the 1960s to the 1980s, it was 50%. “If earnings grow at 5% per year, and if by the end of the decade the payout ratio has returned to 50%, annual dividends will have grown at a double-digit rate, more than double the rate of earnings growth,” Nygren says. He adds that he thinks EPS growth will exceed organic net income growth. “Most of the share repurchases and acquisitions that our companies made last year were funded from cash generated in the normal course of operations, not from a one-time levering up of their balance sheets,” he says.
In his latest column for MSN Money’s Top Stocks, Validea CEO John Reese highlights a handful of high-dividend stocks he thinks are worth a look right now.
“In the months leading up to the fiscal deal, high-dividend stocks have been taking some hits,” Reese writes. “While fiscal cliff and higher taxes on dividends may not be the only reason, no doubt these concerns were playing some role in dividend stocks’ sluggishness.”
But, he says, the declines “have shaken some of the excess bullish sentiment out of high dividend plays, which had gotten fairly pricey earlier this year as investors, starved for yield in the current low-interest-rate environment, flocked to them. What’s more, there’s some intriguing research showing that, historically, high-dividend stocks haven’t suffered when dividend taxes have been high or increasing dramatically.”
Reese discusses that research, and looks at five high-dividend plays that his Guru Strategies — each of which is based on the approach of a different investing great — are high on right now. Among them: Japanese telecom NTT Docomo.
T. Rowe Price’s Tom Huber, whose Dividend Growth fund is in the top 13% of funds in its category over the past five years, according to Morningstar, says that tax increases associated with the fiscal cliff aren’t reason to avoid dividend-paying stocks.
“There is a lot of discussion and worry [about the tax hikes] more than I think it deserves,” Huber tells Barrons.com. “Higher tax rates are not good. But I think [these stocks] have been shown to work over time.”
While consumer staples, utilities, financials, and telecom have traditionally been areas to find strong dividend plays, Huber says that’s changing, with consumer discretionary and tech firms now joining the dividend players. “Utilities and telecom stocks have higher yields, though the payout ratios are higher and dividend growth is slower,” he says. “But because technology stocks are new to the dividend-paying world, the payout ratios tend to be lower, which leaves lots of room to raise payments.”
Huber also talks about his dividend strategy. He says he generally wants his portfolio to have a market-level dividend yield, but he focuses on firms that he thinks can grow their dividend payouts faster than their broader sectors. He talks about some of his current favorite picks, including Automatic Data Processing and Pfizer.
The Wall Street Journal’s Matt Phillips has a simple message for investors: Do not forget about dividends.
“Dividends matter! Dividends matter! Dividends matter!” Phillips writes on the Journal’s “MarketBeat” blog. He references recent commentary from Standard & Poor’s Howard Silverblatt as proof. “We are near another all time high for total return, even as stocks remain 10.2% off their all time high,” Silverblatt said. “We need a 0.14% total return to set a new record, which includes today’s dividends adding .02%.”
Silverblatt says the indicated dividend rate is “up 13.0% from 12/30/2011, 2012 payment estimated to be an all time high. Given the timing of the increases, unless issues decrease their dividends (in which case don’t worry about dividends -> means everything is going down) 2013 already has a +3% payment increase built in.”
With bonds yielding so little, many investors have been looking for yield in the form of high-dividend stocks — which has made some of those picks rise to unattractive valuations. But in his latest article for Forbes.com, Validea CEO John Reese looks at some stocks that are offering nice dividends, and still trading at cheap valuations.
Reese refers to data that top fund manager Bill Nygren cited in a recent letter to shareholders. “Nygren points out that, historically, the top 100 dividend payers in the S&P  have collectively sold at a price/earnings ratio that is about three-quarters of the overall index’s P/E,” Reese says. “Right now, the high-dividend stocks not only aren’t trading at that discount; they’re actually more pricey than the broader index, which trades for about 13 times earnings, Nygren says.”
But, Reese adds, “That, however, doesn’t mean all high-dividend stocks are fully priced. I recently used my Validea.com Guru Strategies (which are based on the approaches of several different great investors, including Warren Buffett and Benjamin Graham) to look for high-dividend plays whose shares are trading for less than 11 times earnings.” He found several, five of which he examines in the article. Among them: Southern Copper, which gets good marks from his Joel Greenblatt-based model.
MarketWatch’s Mark Hulbert says that the stock market is “closer to undervalued” than overvalued, and that the market is “poised to produce above-average returns over the next couple of years.”
Using data from Investment Quality Trends, Hulbert looked at stocks of some of the “highest quality and most profitable companies, as defined by criteria such as an S&P quality ranking in the ‘A’ category, 25 years of uninterrupted dividends, and at least five dividend increases over the last dozen years.” Right now, only about 250 stocks make that list, he says.
IQT puts each of these stocks into one of four categories, depending on how its current dividend yield matches up against the historical range for the stock. Hulbert says his analysis found that a statistically significant inverse correlation exists between the percentage of those stocks that fall into the “overvalued” category and the market’s return over the next several years. The higher the percentage of those quality dividend-payers that are in the “overvalued” category, the worse future stock returns, and vice versa.
Historically, Hulbert says the average number of those dividend payers that have fallen into the overvalued category is 21%. Today, it is 13.8%. While that’s not as low as it was during some major bear market lows, it shows that “the gravitational pull exerted by this long-term dataset is towards higher rather than lower prices,” Hulbert writes.