Beware 'Dividend Aristocrats' that Actually Offer Low Yields, No Real Income 22 comments
- Articles on Seeking Alpha by Cliff Wachtel, Chief Analyst, AVA FX
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With growth investors battered by declining markets, there is lots of talk about investing for dividends. However, unless the stock provides:
- Yields that are high enough to leave you something after real inflation and taxes
- Protection of the value of your principal and income
Then you can profit only if the market rises. That’s a risky bet these days.
Dividends Don’t Necessarily Equal Income After Inflation and Taxes
Income investors should have a clear idea of what % yield they want when selecting stocks for income. There is a distinct difference between ordinary dividend stocks and dividend stocks for income. Many so called "dividend aristocrats," even with their prices beaten down, pay dividends below 5%. Will this give you a meaningful yield after inflation and taxes?
For example, assume you invest $10k in a stock yielding 5%. Your income is $500. Assuming it's a qualified dividend (will Obama leave that alone? questionable) and no Alternative Minimum Tax issues, your after tax return is $425.
Meanwhile, REAL inflation, for those of us who eat meat and produce, use fuel, consume health care services, has been well beyond the supposed 2-3% of the CPI over the past years, at least 5% - more for the above mentioned items.
Yes we may have some temporary deflation given that we're in the worst economic crisis since the Great Depression, but since the government is committed to printing about 13 Trillion new dollars (about the size of our GNP), inflation is just a matter of time.
But ok let's stick with 5% to keep the math easy.
Nominal after tax income: $425. At 5% inflation, your 10K principle in a flat stock market erodes by $500/ year, leaving you with negative real returns. Yes, the better companies grow their dividends over time, but usually not by enough to meaningfully stay ahead of inflation. In the end, low yield stocks are still just another bet on the market rising. A bad bet these days for the near term.
Quality High Yield Stocks-An All Weather Strategy for Steady Returns
My point is that the best strategy for this market is to seek stocks with the following criteria.
1. High Yields: Unless you're getting a minimum of 8% or more (even that may prove inadequate for most stocks if inflation grows the same magnitude as our money supply), you're not getting income. You're just making a bet on the stock market rising, and getting a bit of opportunity cost covered. Quality high dividend stocks pay you up front and have the solid fundamentals to sustain that high yield and give you steady income regardless of the markets' travails. As long as you don't need the cash for the next few years, you can sleep at night and collect income out of proportion to the risks if you choose the right stocks. See my prior and coming blogs.
2. Steady, Reliable Yields Supported by Healthy Businesses: You need to find stocks with yields that are both high and reliable. High yields usually suggest higher risk, but at times that's a misperception of the market. There are stocks with both high yield AND steady yield because the underlying business is sound and able to generate revenues and cash flow needed to sustain and ideally grow the dividend.
3. Protects Against Declining Long Term Dollar Purchasing Power: You need stocks that give you a hedge against the dollar's long term declining purchasing power, typically those tied to better currencies, hard assets, and that have strong market positions that allow for pricing power.
See my prior and future blogs for stocks that meet these criteria. Ticker symbols of recent mentions include: Atlantic Power Corporation (ATPWF.PK), Energy Savings Income (ESIUF.PK), Macquarie Power and Infrastructure Income Trust (MCQPF.PK), Enterprise Products Partners (EPD), and Teppco Partners (TPP). For more risk, but lots more potential reward, Enerplus Resources Fund Trust Units (ERF), Vermilion Energy Trust (VETMF.PK).
DISCLOSURE: I have positions in most of the stocks I cover.
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This article has 22 comments:
Within an equity portfolio, yields that high are unrealistic, except for MLPs and commodity trusts - which, unfortunately, are diminishing assets. For those investments, characteristically, you're converting principal into yield over time. In some cases, you come out ahead, but it's by no means a sure bet, and seldom tax efficient (particularly with Canadian royalty trusts subject to adjustment next year).
The reality investment with the best payoff is a back yard garden, using the new intensive gardening techniques. I suggest "How to grow more vegetables than you ever thought possible on less land than you can imagine." by John Jeavons. The title is accurate! :-))
> jack
And if it's one thing you want in THIS of all environments it's "safe" and "compounding"
You are one of the few contributors who provide useful investing information for long-term investors, and not just hyperbolic rhetoric.
Right now it is easy to find quality stocks yielding 8% or more. However, when the stock market recovers these yields will decrease, so this strategy will need to be adjusted over time.
I look for stocks with yields at a minimum of 5% with strong growth potential, that are close to book value, have a low P/E and forward P/E, and have enough cash-per-share to pay the dividend.
I find that the stock screeners at aaii.com are extremely useful in locating growth stocks with a healthy dividend. I recommend dividend investors look into a membership, which only costs $29 a year.
Learn to read.
On Apr 09 09:10 AM epeon wrote:
> Actually, I love yoyomamma's comments that it is easy to find 8%
> dividend return stocks but as the market recovers, these will go
> to 5%. Wouldn't that be great? I mean, for a stock with a dividend
> yield of 8% to go to 5% just from stock appreciation would mean that
> the stock has appreciated 60%. Man, I want them! Please, YoYoMamma,
> send me a list.
he understood exactly what you were saying. You don't.
On Apr 09 09:19 AM YoYoMama wrote:
> Please read my post again. I never said that 8% yields will go down
> to 5%. I simply said that the yields will decrease as a stock price
> increase. This holds true if the dividend rate remains the same.
> And my name is YoYoMama.
>
> Learn to read.
On Apr 09 09:19 AM YoYoMama wrote:
> Please read my post again. I never said that 8% yields will go down
> to 5%. I simply said that the yields will decrease as a stock price
> increase. This holds true if the dividend rate remains the same.
> And my name is YoYoMama.
>
> Learn to read.
And I also love my investment in Atlantic Power. I've bought more and more in these past few months; love those monthly dividends and the knowledge that it will not be affected by the 2011 tax change in Canada.
> Nominal after tax income: $425. At 5% inflation, your 10K
> principle in a flat stock market erodes by $500/ year, leaving you
> with negative real returns. Yes, the better companies grow
> their dividends over time, but usually not by enough to
> meaningfully stay ahead of inflation.
Cliff - the thesis of your article seems to be "High Quality stocks increase their dividends over time while Low Quality Stocks DO NOT - and thus do not keep up with inflation."
The problem with your thesis is that no one knows ahead of time which companies will grow their dividends in the future. To further cloud your argument many high quality companies have cut or eliminated their dividend. At one time GE, BAC, C, PFE and JPM where all considered high quality steady dividend payors. I really don't know how to tell a high quality stock from a low quality stock. Does anyone?
Your thesis is not supported by the results of the overall market results. Lets take the SP500 - created in 1957. The fact is that the SP500 which, by definition, consists of many high quality and low quality stocks alike has continued to increase its dividends and this increase has kept up with inflation. This is surprising in light of the fact that during the 90's companies paid out lower dividends (when compared to their earnings) - so they could focus on stock buybacks. Despite their stinginess, over the long haul, dividend payments of the aggregate have kept up with inflation.
I suppose if you define "High quality" as a company which pays a meaningful dividend and shares profits with shareholders in a significant way (30 - 70% of earnings) and has consistently paid the same or an increasing dividend over the past 6 or 10 years, then yes their is a "High Quality" dividend payer.
The fact is that is if you buy enough of these companies (diversification), as inflation increases their prices and their profits, they will in the aggregate continue to increase their dividends. This is consistent with the past actions of companies over the last 100's of years and consistent with what is the stated goal of most corporations: to grow profits and to share these profits with shareholders.
The very reason investors buy dividend producing stocks is to create an income stream that keeps up with inflation. They have done that job very well since the onset of modern inflation (which started in 1945).
I'm interested in your reports on ATPWF. I recall reading a recent comment on one of your articles on this company, sounding a caution about return of capital. I would like to understand that issue better, but I can no longer find the comment. Can you either (a) point me to it, or (b) elucidate the consequences of payouts including a return of capital? Many thanks!
A stock that yields 3% today but is growing its dividends at 12% for the next 12 years will provide a 12% yield on cost by 2021.
Historically Dow Jones Industrials Index dividends have grown by 5-6% over the past century. It's true that we are in a bear market now and in a recession, but if you look REALLY long-term ( like 3-4 decades from now) I am confident the yield on cost on an investment in S&P 500 will be much higher and more tax efficient in comparison with the canroys you have been touting..
Most of the Canroys which yield 12% today, were also yielding 12% 6 months ago despite huge dividend cuts in the sector. If you bought PGH at 18 in Jan 2008 when the monthly dividend was at 0.22, you could have thought that you were getting a good deal. Currently with a 0.08 monthly dividend you are actually getting something close to a 5% yield on cost. You MUST learn the difference between current yield and yield on cost before you bash the dividend growth stocks in general.
And last but not least, do not chase yield blindly. Most of these income trusts pay variable dividends every month out of their cash flow. If oil and gas prices rise, your income rises. If oil/gas prices fall, your monthly income falls. The payout is very high as large portion of it is a return of capital, and you can't safely live off the income. Also In order for the canroys to grow they must sell more stock or debt, since they are paying most of their cashflow in dividends.
Most Dividend Aristocrats on the other hand not only regularly increase dividends, but also buy back shares, thus making you stock worth more.
Good Luck in your quest for income. What truly matters to dividend investors is not only current income, but the ability to maintain/sustain and even increase it over time.
My main point, which seems to be lost, is.... If you are looking for a NEW place to invest, right now a stock with an 8% yield is easy to find. When the market recovers, finding a NEWstock to invest in with an 8% yield may not be so easy to find.
I take absolutely no issue with Cliff's article. Only on the point that unless you find a stock with an 8% yield, the stock may not be worth looking into. Many of you seem to agree.
Now, is everyone happy??
On Apr 09 11:51 AM macsmart wrote:
> When the stock price increases, the per cent yields only decrease
> on paper. If you buy the stock when the yield is 8%, and hold the
> stock, your basis determines the yield if the actual payout remains
> the same; you are still getting the 8%.
with city's headed for bankruptcy, and the government headed in the smae direction-- how will these corportaions and ever trusts have money to pay out in dividneds?
Companies that grow their dividend every year feel compelled to maintain this growth in good times and bad. This enables an investor to look at other financial factors of the company that might signal company operating problems going forward. For example, if a company is using debt to maintain the dividend growth, the debt ratios may get out of whack. Additionally, looking at the payout ratio might signal earnings issues in the near term.
So using a dividend growth process enables investors to uncover potential problems that may be on the horizon; thus enabling an investor to may be exit the stock before a price decline in the future. Blindly investing simply for income by looking at high yielders can be a recipe for disaster. These high yielders may have business issues which result in stock price depreciation or a future dividend cut.
Thanks for your comments, Cliff
On Apr 09 08:58 AM Airelon Trading wrote:
> It amazes me the author has a thesis to "beware" of a dividend aristocrats
> in THIS environment, and not once, mentions the ability of dividend
> aristocrats to safely compound their own returns through DRIP.<br/>
>
> And if it's one thing you want in THIS of all environments it's "safe"
> and "compounding"
I'm doing that now, collecting from the likes of etp, tpp.