Dividends Get No Respect

Napoleon Hill in his classic book Think & Grow Rich said: “In every adversity lies the seed of a greater or equivalent benefit.” The recession and the accompanying bear market devastated portfolio values.

Although we are currently in the midst of a powerful recovery, inexplicably, blue chips with dividends remain historically undervalued. It’s as though quality dividend payers are getting no respect.

Today a ten-year treasury bond yields 3.43%. If held to maturity, they offer ultimate safety, but no growth or increasing income potential. Moreover, a looming inflationary environment could deplete purchasing power. Consequently, today’s flight to safety could prove a debilitating trap.

In contrast, the following diversified portfolio of 10 blue chip companies as of the closing price on 9/17/09 would offer a starting dividend yield approximately equal to 10-year T-Bonds (approx. 3.35%). Also, each has a history of increasing their dividend at a growth rate that is higher than the S&P 500. Better yet, all are valued below their historical normal PE ratio, and have a consensus forecast to grow earnings at 9% or better for the next five years.

We believe this offers a rare opportunity for prudent investors seeking current income and safety, with an inflation hedge built in. Normally you could not find this level of quality with a yield this close to 10-year T-Bonds. It’s possible, if not probable, that you may never see this opportunity again.

Our Graham Dodd adjusted Fundamentals-at-a-Glance Research Tool™ puts this uncommon opportunity into vivid perspective. Since a picture is worth a thousand words, Figures 1-10 below tell an epic story.

How to Read the Charts & Graphs

First, a few pointers on reading the graphs: The green line with white triangles, plots earnings per share multiplied by Ben Graham’s formula for value (except HDBK). The blue line with asterisks show the historical normal PE ratio the market has capitalized earnings at. The black line represents monthly closing stock prices.

Simply put, when the black line (price) touches the blue line (value), the company is fairly priced by the market. When price is above the blue line, it’s overvalued, and when below the blue line, it’s undervalued.

Under the graphs are performance tables. The tables show the dividend paid each year for the last 20 years, multiplied by the number of shares purchased with $100,000 on day one (just for ease of calculation). The table illustrates what we call “growth yield” and the dividends are assumed spent, not reinvested.

The closing cash value reflects appreciation versus the S&P 500. All charts are for 20 years, except Hudson City Bancorp., Inc. (HCBK) which only has a 12-year chart and as a faster growing company is not Graham Dodd adjusted.

Note: Click each chart to enlarge it, then click off to the side of the chart to reduce it back.

Fig. 1. ADP 20yr EPS & Price Correlation

Fig. 2. CLX 20yr EPS & Price Correlation

Fig. 3. FPL 20yr EPS & Price Correlation

Fig. 4. HCBK 12yr EPS & Price Correlation

Fig. 5. JNJ 20yr EPS & Price Correlation

Fig. 6. KMB 20yr EPS & Price Correlation

Fig. 7. MCD 20yr EPS & Price Correlation

Fig. 8. PEP 20yr EPS & Price Correlation

Fig. 9. PG 20yr EPS & Price Correlation

Fig. 10. SYY 20yr EPS & Price Correlation

Conclusion

According to an article in Fundfire magazine today, Mercer, a prominent institutional consulting firm reports a sharp rise in fixed income searches and a severe drop in equity manager searches during the first half of this year. There is a lot of anecdotal evidence suggesting the same trend is occurring with retail investors as well. We are concerned that this violates the most basic law of investing: Buy low, sell high. Quality blue chip dividend paying stocks are historically low today. Fixed income values are high (low yields).

The above portfolio represents a competitive yielding equity portfolio with above-average growth potential, attractive valuation and reasonably high safety. There are higher yielding stocks available, but usually offer lower growth potential. However, they could be blended with the above to increase yield at the expense of growth.

We believe that investors deserve a raise in pay each year. The opportunity to achieve this is, in our opinion, more attractive now than it’s been in many decades. Last year’s cloud has a golden lining - are you mining your share?

Full Disclosure: Long ADP, CLX, FPL, HCBK, JNJ, KMB, MCD, PEP, PG, SYY

Comments

[Tack:]

We have been passing through the greatest period of opportunity for dividend-paying-stocks in history, or at least in my sixty years of lifetime. This is especially true for various preferred and exchange-traded debt issues, which were crushed into oblivion, just like their common-stock breathren. While it might have made sense to have common shares obliterated on uncertain earnings outlooks, it made little sense for the higher-capital-structure issues to follow in tandem unless all the firms were going to go bankrupt. This is how the market was pricing issues, almost across the board, even though this was ridiculous as a generalization.

Now, many of these issue have made startling rebounds, but some still have a significant distance to travel before they regain pricing which represents interest-rate spreads, rather than payment-risk or bankruptcy premiums.

Two areas which remain undervalued, in my own assessment, are commercial realty issues, where total disaster remains calculated into common shares and sizable discounts into preferred prices, and business development companies (BDC's) which appear radically undervalued, if one believes that the economy will revive and IPO markets will again thrive.

Sep 21 11:41 AM

[TLassen:]

dick black
you choose at the time of purchase whether you wish to receive dividends in cash or drip (re-invest in same security)
I am with TD Waterhouse.

On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends. They put the cash into your account every quarter.
> If anyone has a discount broker that reinvests PLEASE clue me in.
> I see/saw the power of reinvested dividends with my mom growing her
> small shares in the original ATT as an employee and following through
> to the divestiture into "regional" telcos and the shares growing
> and growing and NOW she is taking the dividends as supplements to
> her pension which has not grown in 20 years of retirement.

Sep 21 12:09 PM

[jg1945:]

fidelity lets you reinvest dividends...and you have the option of changing that to take it in cash

Sep 21 12:36 PM

[Chuck Carne...:]

mdpath,

Thanks for pointing out the typo. You are right. HCBK is the correct symbol.

Sep 21 12:44 PM

[User 489188:]

I have accounts with both Sharebuilder and TDAmeritrade. Both brokers automatically reinvest dividends and will pruchase partial shares as needed. Good luck.


On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends. They put the cash into your account every quarter.
> If anyone has a discount broker that reinvests PLEASE clue me in.
> I see/saw the power of reinvested dividends with my mom growing her
> small shares in the original ATT as an employee and following through
> to the divestiture into "regional" telcos and the shares growing
> and growing and NOW she is taking the dividends as supplements to
> her pension which has not grown in 20 years of retirement.

Sep 21 02:25 PM

[granger:]

Great post, thank you. Those quick snapshot profiles on the companies are amazing and powerful examples. Keep it coming.

Sep 21 02:43 PM

[pitboss33704:]

Because i happen to agree with this article , I happen to agree w/ its author ..
I have always reinvested dividends - akin to dollar cost averaging as far as I am concerned ..

Sep 21 03:13 PM

[David Van K...:]

Good article.

Over long periods of time, study after study shows that dividend-paying stocks outperform (in TOTAL performance) non-dividend payers.

It is not unusual in a strong market runup--such as the current 6-month rally--for dividend-paying stocks to lag the non-dividend-payers, which usually lead the market up with faster growth (just as they usually lead a declining market down with faster declines). Because of this, stocks of good, solid companies, such as those mentioned in this article, are often available with decent starting yields (say 3%-4% or more). (The yields were even better before the market run-up.)

As to re-investment of dividends: Re-investment accelerates dividend growth. But if you have the time to study the stocks you own, you may not want to have the dividends re-invested in each company that issued them. I deliberately choose not to have my dividends automatically re-invested. Instead, I let the dividends in my dividend portfolio accumulate to a certain amount (currently $1000), and then I re-invest them myself in the most attractive divedend company on my list. This is, after all, the investment of "new money," and I feel that it deserves the same attention to detail as any other new investment.

Sep 21 06:30 PM

[mkreisel:]

It's not only that dividend stocks don't get respect, companies with stable earnings in general don't get any respect during the current rally.

The show belongs to garbage with one leg in bankruptcy grave, such as AIG, C, FNM, FRE, and LVS.

Sep 21 07:05 PM

[Teak:]

Charles Schwab also allows one to reinvest dividends. You make the choice at the time of purchase, but also have the option to change it later.


On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends.

Sep 21 08:37 PM

[Dividend Di...:]

I'm a "greenhorn" in terms of investing and specifically dividend investing. My early research suggested that a conservative portfolio of fairly valued dividend growth payers was the ideal portfolio for the long term. Originally, automatic dividend reinvestment of equities in a Roth seemed like the tax-efficient, low-cost way to supplement a 401k. However, after reading the likes of D4L, DGI, and David Van Knapp, accumulating the dividends might make more sense.

Don't get me wrong, the concept of dollar cost averaging has its merits. But what about it terms of the dividend? I think I agree with David in that - If you're taking the time to calculate fair value to determine your entry price, shouldn't you be considering the fair value price of your dividend reinvestment? What if your blue-chip has run-up in price prior to receipt of the dividend and is "overvalued"? You might snap back, "I'm a buy-and-hold, long-term investor...I don't care because in the long run it doesn't really matter."

Let's assume you're a young investor and starting with a small portfolio. You might still be able to make accumulating the dividends cost effective. You choose a broker with free dividend reinvestment to prevent trade costs from eating potential returns. You open a brokerage account at a discount broker using your 2009 and 2010 Roth IRA contributions ($10,000). You purchase a "diversified" portfolio of 10 stocks ($1000/each) using your free trades for being a new customer. Zero cost thus far. In year 1, you accumulate $350 in dividends, assuming an average portfolio yield of 3.5%, which is highly feasible based on the author's analysis. Rather that reinvest those dividends throughout the year for free, you decide to accumulate your dividends and purchase either an additional stock or invest more in one of the stocks in your portfolio. But now, you're no longer a new customer, and commissions are $7/trade, arguably market average for discount brokers.

I've read a good rule of thumb is to keep costs at 2% of your investment amount...in this case your $7 transaction cost is exactly 2% of your $350 investment purchase. Assuming you were smart enough to buy the most attractively valued stock, you could make the argument that you made a very wise investment decision if..for instance the other 9 stocks in the portfolio skyrocketed in price throughout the year.

All of that is contingent on the fact that you like to take the time to research and value your portfolio holdings throughout the year. I think the jury is still out in my case, but I'm leaning towards the "accumulate and buy" over the automatic dividend reinvestment philosophy. Thoughts?

Sep 21 08:46 PM

[jessducky:]

Fidelity gives you the option to reinvest dividends in shares for most companies..


On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends. They put the cash into your account every quarter.
> If anyone has a discount broker that reinvests PLEASE clue me in.
> I see/saw the power of reinvested dividends with my mom growing her
> small shares in the original ATT as an employee and following through
> to the divestiture into "regional" telcos and the shares growing
> and growing and NOW she is taking the dividends as supplements to
> her pension which has not grown in 20 years of retirement.

Sep 21 09:10 PM

[Tom B:]

Etrade can also reinvest dividends. I don't; it complicates matters at tax time.


On Sep 21 02:25 PM User 489188 wrote:

> I have accounts with both Sharebuilder and TDAmeritrade. Both brokers
> automatically reinvest dividends and will pruchase partial shares
> as needed. Good luck.

Sep 22 10:48 AM

[KSAccountant:]

I am with both E-Trade and Firstrade and both have an option to reinvest my dividends which I do on a regular basis. However, you have to sign a form for them to do so. With Firstrade it is a general blanket "reinvest all dividends" and they have a link right on their main page. With E-Trade, you have to opt into every stock you purchase (usually can do so three days after purchase) which can be a problem if you forget. E-Trade has a link "reinvest dividends" on their portfolio summary page.


On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends. They put the cash into your account every quarter.
> If anyone has a discount broker that reinvests PLEASE clue me in.
> I see/saw the power of reinvested dividends with my mom growing her
> small shares in the original ATT as an employee and following through
> to the divestiture into "regional" telcos and the shares growing
> and growing and NOW she is taking the dividends as supplements to
> her pension which has not grown in 20 years of retirement.

Sep 22 12:54 PM

[Dividend Di...:]

You can select the option on a stock by stock basis. From Firstrade's website:

"Sign up for Firstrade's free Dividend Reinvestment Plan
(DRIP) and automatically accumulate your positions every time you receive a dividend! You can enroll either a single eligible stock or all eligible stocks in your portfolio. Enjoy the benefits of compounding returns on your investment without having to place an order, pay a commission, or even purchase a round number of shares."


On Sep 22 12:54 PM KSAccountant wrote:

> I am with both E-Trade and Firstrade and both have an option to reinvest
> my dividends which I do on a regular basis. However, you have to
> sign a form for them to do so. With Firstrade it is a general blanket
> "reinvest all dividends" and they have a link right on their main
> page. With E-Trade, you have to opt into every stock you purchase
> (usually can do so three days after purchase) which can be a problem
> if you forget. E-Trade has a link "reinvest dividends" on their portfolio
> summary page.

Sep 22 01:33 PM

[agricolae:]

try E*Trade


On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends. They put the cash into your account every quarter.
> If anyone has a discount broker that reinvests PLEASE clue me in.
> I see/saw the power of reinvested dividends with my mom growing her
> small shares in the original ATT as an employee and following through
> to the divestiture into "regional" telcos and the shares growing
> and growing and NOW she is taking the dividends as supplements to
> her pension which has not grown in 20 years of retirement.

Sep 23 05:30 AM

[agricolae:]

I think E*Trade will reinvest dividends.

Sep 23 05:32 AM

[pakatron:]

I use tradeking. They also give you the option to reinvest dividends or take them as cash.


On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends. They put the cash into your account every quarter.
> If anyone has a discount broker that reinvests PLEASE clue me in.
> I see/saw the power of reinvested dividends with my mom growing her
> small shares in the original ATT as an employee and following through
> to the divestiture into "regional" telcos and the shares growing
> and growing and NOW she is taking the dividends as supplements to
> her pension which has not grown in 20 years of retirement.

Sep 23 08:20 PM

[pgilbert:]

Sharebuilder will reinvest dividends for free.


On Sep 21 11:38 AM dick black wrote:

> The biggest problem I see is that discount brokers DO NOT REINVEST
> dividends. They put the cash into your account every quarter.
> If anyone has a discount broker that reinvests PLEASE clue me in.
> I see/saw the power of reinvested dividends with my mom growing her
> small shares in the original ATT as an employee and following through
> to the divestiture into "regional" telcos and the shares growing
> and growing and NOW she is taking the dividends as supplements to
> her pension which has not grown in 20 years of retirement.

Sep 25 07:05 PM

[DonFurio:]

Overall I think dividends are overlooked by many investors. Also, I think some people forget that currently most dividends are only taxed at 15% vs your marginal rate.

I would hardly say that they get no respect. Many of the companies you mentioned fell by a much smaller % than the overall market during the downturn, so it's natural that they won't have the same gains from the bottom as others.

Oct 02 03:46 PM