If I were a dividend, Id fire my press agent. Id
be jealous and feel neglected because stock prices get a lot
more attention than they deserve. The only time dividends make
headlines is when they get reduced, because dividend cuts (or
omissions) often go hand in hand with stock price declines. The
stock is a victim; the dividend is the bad guy.
But if I were a dividend, Id be more upset because I
never get the credit I deserve. Over the past century dividends
delivered close to half of all stock market returns. Think
about that. If you were fortunate to be alive for the past 100
years and had your money invested in the stock market, half of
your returns would have come from dividends.
However, the above statement needs an important
clarification: It sometimes takes decades for investors in
broad stock market indexes to obtain average
returns. Historically, the stock market has gone through
exciting phases of above-average returns (secular bull
markets), which were usually followed by less satisfying phases
of below-average returns (secular sideways markets), each
lasting about a decade and a half.
I have written about why my research leads me to believe we
are in a long-lasting sideways market. During the past three
sideways markets, dividends were responsible for more than 90
percent of stock market returns. Yet the current dividend yield
of the S&P 500 index is only 2.1 percent, less than half of
what stocks yielded, on average, over the past century.
A few months ago a client asked my firm if we could come up
with a defensive stock portfolio that would yield more than 7
percent. In an environment in which the Federal Reserve has let
loose a jihad on interest rates and carpet bombed anything even
remotely resembling yield through its purchase of riskless (or
near-riskless) instruments of all durations, I thought it was
not doable. Most stable, income-producing assets (I am not even
talking about bonds), such as real estate investment trusts,
yield a miserable 3 percent or so and are likely to be
candidates to short, not buy, in the long run.
To my surprise, we have been able to identify a diversified
portfolio of 20 stocks that meet the 7 percent hurdle. We have
had to step outside the U.S. of A.: Half of the portfolio is in
European (mostly multinational) stocks, a quarter is in master
limited partnerships, and the rest is in plain-vanilla U.S.
Here are two stocks that we are considering for the
Vodafone Group is one of the largest global
mobile phone companies in the world and yields more than 8
percent, counting annual recurring special
dividends. It has an A-rated balance sheet, and it can pay off
any annual debt maturity from its ample free cash flow. In
addition, at some point Europe will come out of what seems to
be a perpetual recession, and Vodafones earnings growth
will accelerate. The companys crown jewel its 45
percent stake in Verizon Wireless will be monetized. The
Indian market, where Vodafone is a big player, will continue to
improve, and the company will start earning a reasonable return
on investment there. Last, our societal addiction to being able
to access the Internet anywhere at any time on any device will
kick into ever-higher gears, and data sales will accelerate
Vodafones revenue growth.
Ekornes is a Norwegian manufacturer of
pricey furniture that is sold all over the world. Despite
making its gorgeous products in high-cost countries like Norway
and the U.S., the company is still achieving an impressive
return on capital. It is run with Norwegian conservativeness:
It has no debt and a cash-rich balance sheet and remained
profitable even in the midst of the Great Recession. Its stock
sports a yield of more than 7 percent, which will likely go up
once the situation in Europe normalizes.
Though this may sound banal, Ive often seen it happen
that in the quest for yield in a very low-rate environment,
yield can easily turn into a shiny object that obfuscates
ones analytical thinking. Investors suspended their
judgment and held on to high-dividend-paying financial stocks
in the early phase of the financial crisis because of those
dividends and we know how that story played out.
Analysis of high-yielding stocks should come with a warning
label: Dividends are only part of the equation, and ones
analysis of a high-dividend stock should not be any different
from that of a low-yielding one. After all, sustainable
high-dividend yield is just a by-product of a companys
low valuation (it usually serves as a good indicator of value)
and capital allocation decisions.
Once you find a company with a high and sustainable
dividend yield, its price-earnings ratio has to work a
lot less hard for you to receive a good future return.
Vitaliy Katsenelson (firstname.lastname@example.org) is CIO at Investment
Management Associates in Denver and author of
The Little Book of Sideways Markets.