The Shrinking Dividend Yield

|
 |  Includes: IYY
by: AAII

One consequence of the market's ongoing rally has been shrinking dividend yields. The Dow Jones U.S. Index (NYSEARCA:IYY), an exchange-traded fund that tracks the largest 1,200 domestic stocks, yielded just 1.9% at the end of last week. Within the slightly broader S&P Supercomposite 1500 index, just 263 members traded with yields above 3.0% according to AAII's stock screening and database program, Stock Investor Pro.

I'll admit that 263 sounds like a number that would still give income-hungry investors plenty of choices, but adding two key filters quickly narrows this list. The first filter is a requirement for dividend growth. Research from Ned Davis Research shows that shares of companies that raise or initiate dividends greatly outperform shares of companies that do not raise their dividends. The second is free cash flow. In order to continue paying and raising a dividend in the future, a company has to generate more cash than it spends.

Merely requiring positive dividend growth cuts the list nearly in half to 133. Requiring dividends to grow faster than the rate of inflation, which is currently at 2% according to the February Consumer Price Index, narrows the list down to 118. (If dividends grow slower than inflation, the purchasing power of the quarterly payments is reduced.) Adding in a requirement for positive free cash flow cuts the list even further, down to 79. A table with all 79 companies is published below.

Keep in mind that I have not considered other important factors such as price-earnings ratio or earnings growth. Adding these components would narrow the list of passing stocks even further. You could potentially find a few additional names by analyzing the 26 utility stocks that were eliminated by the free cash requirement, but overlaying valuation would still keep the list restrictive.

Needless to say, if you are someone who seeks dividend income, these are not numbers that will make you smile.

Could you find higher yields? Absolutely, but you are also taking on greater risk to seek income now. High yields are a sign that other investors perceive problems and want a higher yield to be compensated for those risks. In the current market environment, stocks with yields above 4.5% should be analyzed closely. There might be some bargains, but since higher yields imply lower valuations, it is important to remember that some stocks are cheap for a reason.

I would also suggest thinking about total return, a strategy we use for managing the AAII Dividend Investing portfolio. Though this can be a tough concept for those of you who adhere to the "take income only and never touch principal" methodology, I will point out that both price appreciation and income contribute to wealth. From the standpoint of investing in equities, you should be indifferent as long as you are realizing long-term gains and qualified dividends. At the end of the day, it is a question of what dollar amount you are able to safely withdraw from your portfolio, not whether those dollars were funded by capital gains or dividend income (assuming, of course, the tax consequences are equal).

Table 1. Dividend Stocks With Yields Above 3% and Positive Free Cash Flow

Company Ticker Dividend Yield (%) Dividend Growth TTM (%) Free Cash Flow TTM ($) Price-Earnings
Ratio
Index
Membership
Altria Group Inc MO 5.1 7.6 0.19 16.9 S&P 500
Analog Devices, Inc. ADI 3.1 23.7 0.89 20.9 S&P 500
Arthur J. Gallagher & Co. AJG 3.4 3.0 0.67 25.8 MidCap 400
AT&T Inc. T 4.7 2.3 1.63 31.4 S&P 500
B&G Foods, Inc. BGS 4.0 27.9 0.77 24.3 SmallCap 600
BB&T Corp. BBT 3.1 25.0 4.26 11.1 S&P 500
Bristol Myers Squibb Co. BMY 3.4 3.0 2.47 35.3 S&P 500
Broadridge Financial Solutions BR 3.1 9.7 1.29 22.1 MidCap 400
Brooks Automation, Inc.(NYSE:USA) BRKS 3.4 100.0 0.13 5.0 SmallCap 600
CA, Inc. CA 4.1 426.3 1.99 12.4 S&P 500
Cablevision Systems Corp. CVC 4.2 4.3 0.95 120.1 S&P 500
Calamos Asset Management, Inc CLMS 4.4 7.9 5.75 12.8 SmallCap 600
CenterPoint Energy, Inc. CNP 3.5 2.5 0.71 24.6 S&P 500
Chevron Corp. CVX 3.1 13.6 0.52 8.8 S&P 500
Cisco Systems, Inc. CSCO 3.3 83.3 1.55 11.8 S&P 500
City Holding Company CHCO 3.8 2.2 2.15 14.9 SmallCap 600
Community Bank System, Inc. CBU 3.7 6.0 1.44 15.0 SmallCap 600
Comtech Telecomm. Corp. CMTL 4.6 4.8 0.79 20.3 SmallCap 600
Cullen/Frost Bankers, Inc. CFR 3.1 3.8 2.57 16.1 MidCap 400
Cypress Semiconductor Corp. CY 4.1 22.2 0.22 n/a MidCap 400
Darden Restaurants, Inc. DRI 4.0 24.0 0.20 14.4 S&P 500
Diebold Inc. DBD 3.8 2.2 0.22 23.4 MidCap 400
ENSCO PLC ESV 3.5 7.1 0.17 11.1 S&P 500
Exelis Inc XLS 3.7 310.0 0.98 6.4 MidCap 400
Federated Investors Inc FII 4.1 157.3 0.51 12.9 MidCap 400
First Financial Bancorp FFBC 7.2 51.3 2.01 13.7 SmallCap 600
Ford Motor Company F 3.2 300.0 0.70 8.8 S&P 500
Gannett Co., Inc. GCI 3.9 233.3 2.06 13.1 S&P 500
Garmin Ltd. GRMN 5.4 6.3 1.96 12.2 S&P 500
General Dynamics Corp. GD 3.2 8.5 3.79 n/a S&P 500
General Electric Company GE 3.3 14.8 0.85 16.5 S&P 500
Harris Corp. HRS 3.3 25.6 4.41 9.1 S&P 500
Hasbro, Inc. HAS 3.7 20.0 1.51 17.1 S&P 500
Horace Mann Educators Corp. HMN 3.6 19.6 4.37 8.5 SmallCap 600
Intel Corp. INTC 4.3 11.2 0.53 9.8 S&P 500
JPMorgan Chase & Co. JPM 3.2 20.0 5.19 9.2 S&P 500
Kimberly Clark Corp KMB 3.3 5.7 2.63 22.5 S&P 500
KLA-Tencor Corp. KLAC 3.1 25.0 3.17 12.6 S&P 500
Laclede Group Inc LG 3.9 2.5 1.20 15.4 SmallCap 600
Leggett & Platt, Inc. LEG 3.6 3.6 1.22 19.4 S&P 500
Lexmark International Inc LXK 4.6 360.0 2.55 17.5 MidCap 400
Lorillard Inc. LO 5.4 19.4 0.75 14.4 S&P 500
Lumos Networks Corp LMOS 4.2 300.0 0.01 17.4 SmallCap 600
Mattel, Inc. MAT 3.4 7.8 1.75 19.3 S&P 500
Merck & Co., Inc. MRK 3.8 10.5 0.96 22.6 S&P 500
Meredith Corp. MDP 4.3 33.3 2.27 15.5 MidCap 400
Meridian Bioscience, Inc. VIVO 3.4 25.0 0.10 26.2 SmallCap 600
Microsoft Corp. MSFT 3.2 19.4 2.44 15.8 S&P 500
Molex Inc. MOLX 3.1 11.0 0.39 18.1 S&P 500
National Penn Bancshares NPBC 3.9 355.6 0.64 15.6 SmallCap 600
Northrop Grumman Corp. NOC 3.1 12.0 7.09 9.2 S&P 500
Northwest Bancshares, Inc. NWBI 3.9 11.6 0.55 18.3 SmallCap 600
NV Energy, Inc. NVE 3.6 30.6 0.66 15.5 MidCap 400
PacWest Bancorp PACW 3.5 243.5 2.37 18.3 SmallCap 600
Parkway Properties Inc PKY 3.4 25.0 0.84 n/a SmallCap 600
Paychex, Inc. PAYX 3.8 3.2 0.46 22.7 S&P 500
Pennsylvania R.E.I.T. PEI 3.8 5.0 0.04 n/a SmallCap 600
Philip Morris International In PM 3.7 14.9 1.74 17.9 S&P 500
Pinnacle West Capital Corp. PNW 3.8 27.1 0.49 16.6 S&P 500
Provident Financial Services, Inc. PFS 3.5 6.3 1.04 12.5 SmallCap 600
Raytheon Company RTN 3.8 16.3 2.72 10.3 S&P 500
Reynolds American, Inc. RAI 5.3 8.4 0.31 19.7 S&P 500
Sabra Health Care REIT Inc SBRA 4.7 37.5 0.17 55.8 SmallCap 600
Safety Insurance Group, Inc. SAFT 4.9 10.0 4.35 12.8 SmallCap 600
Schweitzer-Mauduit Internation SWM 3.1 50.0 4.22 14.6 SmallCap 600
Seagate Technology PLC STX 4.3 181.5 7.24 4.7 S&P 500
Simmons First National Corpora SFNC 3.4 5.3 1.19 15.1 SmallCap 600
Sonoco Products Company SON 3.5 3.5 0.98 17.9 MidCap 400
SYSCO Corp. SYY 3.3 3.8 0.02 18.8 S&P 500
Texas Instruments Inc. TXN 3.3 28.6 1.84 22.6 S&P 500
Tompkins Financial Corp. TMP 3.6 5.8 2.63 17.0 SmallCap 600
Tower Group International Ltd TWGP 3.6 8.7 0.75 n/a SmallCap 600
Tupperware Brands Corp. TUP 3.1 20.0 2.60 23.4 MidCap 400
Universal Corp UVV 3.6 2.1 9.27 11.8 MidCap 400
Verizon Communications Inc. VZ 4.2 2.8 2.15 159.9 S&P 500
Waste Management, Inc. WM 3.8 4.4 0.27 21.9 S&P 500
WestAmerica Bancorp. WABC 3.3 2.1 2.65 15.1 MidCap 400
Western Union Company, The WU 3.5 37.1 1.08 8.5 S&P 500
Wisconsin Energy Corp. WEC 3.2 15.4 0.82 18.2 S&P 500
Click to enlarge

Charles Rotblut, CFA is a Vice President with the American Association of Individual Investors and editor of the AAII Journal.

Disclosure: I am long CSCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: AAII holds positions in T, CVX, INTC, LEG, MSFT, and WEC in our model portfolios.