Nygren: Dividends Will Be Key

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.

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High-Dividend Stocks for the Gurus

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.

Top Dividend Manager Talks Strategy

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.

Don’t Ignore The Dividends

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.”

Stocks Offering Nice Dividends — And Value

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 [500] 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.

Dividend Data Points to Market Being Undervalued

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.

Zweig: Dividends Aren’t Easy Money

While investors overall are still lukewarm on U.S. stocks, one section of the market they have been keen on in 2012 is dividend stocks — perhaps too keen, says Jason Zweig.

In his Intelligent Investor column for The Wall Street Journal, Zweig says that so far this year, investors have put a net of $9 billion into mutual funds and exchange-traded funds focused on U.S. stocks that pay stable, high or rising dividends, according to EPFR Global; all other U.S. stock funds have a combined net outflow of $7.3 billion.

“Many of the investors joining the dividend stampede appear to be motivated by the low interest rates mandated by the Federal Reserve, which have led to a yield famine among traditional income investments like bonds, certificates of deposit and money-market funds,” Zweig writes, adding that others may be chasing performance, since high-yield stocks fared well last year. But, he says, “Think twice before you jump on the bandwagon. While dividend-oriented funds are a perfectly legitimate way to invest in stocks, you shouldn’t mistake them for bonds.” While it may pay a nice dividend, there’s no guarantee you’ll get your capital back with a dividend stock, he says.

In fact, while many believe dividend stocks are much safer than the broader market, Zweig says that’s not true. “In the long run, dividend-paying stocks are slightly less risky — and more rewarding — than the equity market as a whole,” he says. “In the short run, however, they can expose you to the risk of being in the wrong place at the wrong time.” And, he says unless Congress and the White House act, dividend tax rates could jump significantly next year. So, while there are reasons to buy dividend stocks, Zweig says not to see them as easy ways to generate income in a low-bond-yield environment.

Dividends a “Powerful Theme”, Says Top Fund Manager

Royce and Associates’ Charlie Dreifus, whose Royce Special Equity fund is in the top 11% of its category over the past ten years and the top 5% over the past five years, says dividends “will be a powerful theme for the future” for stock investors.

“Our basic hypothesis is that companies with a moderate current yield, increasing dividends, and reasonable valuations and are also financially productive are more likely to produce market-beating returns,” Dreifus tells Morningstar. “The alpha we see coming from increasing dividends is a function of several factors. One, sovereign debt downgrades have caused investors to seek high-quality substitutes. Two, an aging population is seeking income. Three, ongoing and rising dividends are a layman’s shortcut to determining earnings quality. All of these speak to the increasing importance of the dividend component of total return.”

Dreifus stresses that he’s not looking for the highest yielders, but instead “consistent dividend growers with supporting, solid free cash flow generation”.

While his Special Equity fund targets small-caps and micro-caps, Dreifus also manages the Royce Special Equity Multi-Cap fund, which debuted in 2011 and was in the top 3% of funds in its category last year, according to Morningstar. Right now, it’s in larger small-cap stocks that he says he’s finding the biggest opportunities. “For some time, we have found the larger small-cap names more attractive,” he says. “Some of that no doubt is because of the significant price appreciation in the smaller, lower-quality small-cap issues off the March 2009 bottom. This is the usual pattern after a decline and often leaves the larger quality names relatively neglected, which has historically worked well for us.”

Dreifus also talks about the rigorous battery of financial tests he puts his holdings through, and why he likes some names in the consumer cyclical sector.

 

 

 

 

 


OSAM: Shareholder Yield Surpasses Dividend Yield

While paltry fixed-income yields have had investors on the prowl for high-dividend stocks, James O’Shaughnessy’s firm says they should be looking in another place for yield.

“Though dividend yield works very well internationally, investors in U.S. stocks should instead focus on shareholder yield, a factor we have long advocated that has provided considerably stronger returns for U.S. stocks for more than 80 years,” writes Patrick O’Shaughnessy on O’Shaughnessy Asset Management’s web site. Shareholder yield is the total of a company’s dividend yield and its share buyback yield. “Our research shows that buybacks are very strong buy indicators — while share issuances (primary or secondary offerings) are a bad sign for the stock’s returns in the following year,” O’Shaughnessy writes.

The benefit of shareholder yield over dividend yield is its flexibility, O’Shaughnessy adds — what’s important is that firms are returning cash to shareholders, regardless of whether it is through dividends or stock buybacks. Back-testing data back to 1927, he says OSAM found that the top decile of stocks based on dividend yield returned an average of 11.72% annualized, vs. an all stocks benchmark of 10.37%. The top decile based on shareholder yield, however, was even better, with annualized returns of 13.12%.

O’Shaughnessy also discusses why stock buybacks are more prevalent in the U.S. than many other foreign markets, and looks at how returns can be boosted by combining shareholder yield with other fundamental variables. For example, using data that goes back to 1963, OSAM found that taking the top quintile of stocks based on shareholder yield, and then taking from that group the top quintile based on EBITDA/Enterprise Value, an investor could have posted annualized returns of 17.31%.

“We believe that now is an excellent time to be buyers of stable, market- leading U.S. firms — those firms that are rewarding their shareholders with large cash transfers — at discount prices,” O’Shaughnessy concludes. “We encourage yield-seeking investors to consider more than just dividends alone. Familiar companies like Lockheed Martin, Intel, Travelers, and The Gap are good examples of stocks that meet these criteria at present. By owning these types of stocks, investors can benefit from a yield factor that has proven to be particularly effective throughout lengthy time periods and across a variety of market conditions.”