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Dividend-paying stocks are so 2011, right?

The big, stodgy companies that pay dividends to shareholders did well when the markets were sinking last year. Consumer-staples stocks, utilities, telecoms, what have you, all set the pace while investors avoided growth like the plague.

But since someone pushed the “risk-on” button last October, dividend-paying warhorses have lagged the market’s fleet fillies—small-cap stocks and emerging markets. Even so, many dividend-paying stocks trade near their 52-week highs.

Yet there’s still a strong case to be made for these stocks, although I would wait for a market pullback to buy them or add to what you have.

It comes down to yield in a low-return world: The possibility of increasing income, which is unlikely with bonds at this point, as well as relative protection in bear markets, and simply nowhere else to go for most people. And there’s one more compelling reason to own these stocks, which I’ll get to later.

But the most important reason, of course, is yield. Federal Reserve chairman Ben S. Bernanke has pushed the federal funds rate down to near zero, and will keep it there for at least two more years.

So, savers are earning less than 1% from even the highest paying money market funds. Other accounts pay even less. It’s a joke.

As for bonds, Treasuries yield anywhere from 0.25% on the short end to less than 2% for ten-year notes, and barely 3% for 30-year bonds. And investors have poured nearly $800 billion into taxable bond funds since 2007, so they could suffer capital losses if bonds sell off, as many expect them to.

“There is a desperation on the part of a lot of investors who require cash flow and are not getting it off other investments,” said Charles Carlson, chief executive officer of Horizon Investment Services and editor of DRIP Investor, an investment newsletter that focuses on dividend-paying stocks.

Meanwhile, the S&P 500 index yields just over 2%, and the Dow Jones Industrial Average yields 2.5%. Both yield more than the ten-year Treasury, only the second time that’s happened since 1947. The last time was near the market bottom in 2008-2009.

And the really good news is that companies can always raise dividends…and some do consistently.

Corporations certainly have the wherewithal to boost payouts. Earnings of the S&P 500 have taken off by an amazing 125% since the end of 2009. And though their gains have slowed, analysts and strategists still expect earnings to grow in the mid-single digits.

As I’m sure you know, nonfinancial companies in the S&P 500 hold nearly $2 trillion in cash on their balance sheets; Apple (AAPL) alone has almost $100 billion in cash.

That huge cash hoard allows corporations to boost their dividend payouts and stock buybacks, which also help lift share prices. (There’s even speculation about Apple instituting a stock dividend, but I’ll believe it when I see it.)

Dividends paid by S&P 500 companies in 2011 totaled $240 billion, a 16% jump from 2010 and the highest level since 2008, according to DRIP Investor. And in the 12 months ended September 2011, “positive” dividend actions (instituting or raising a dividend) outnumbered “negative” actions (reducing or suspending dividends) by 328-6. (The ratio was a much narrower 1.4:1 in the 12 months ended September 2009, according to S&P.)

In fact, as Carlson points out, the current dividend payout ratio of 28% (the percentage of corporate profits paid out in dividends) is far lower than its 20-year average payout ratio of 40%. So there’s plenty of room for growth there.

And these stocks also may offer higher returns than you’d expect.

In a research note, three fund managers at BlackRock—Robert Shearer, Kathleen Anderson, and David Cassese—wrote: “Dividend payers historically have outperformed non-dividend payers over the long term with lower volatility than the broader stock market.”

In fact, they say dividend-paying stocks have beaten non-dividend-paying stocks in the S&P by three percentage points—20.6% to 17.2%—over all ten bull markets since 1972, according to data from Ned Davis Research. And dividend payers suffer half the losses of non-dividend payers in all the bear markets during that time. What’s not to like?

That brings us to one of the best reasons for investors to own dividend-paying stocks—they’re the least scary equities at a time when people are terrified to be in the market.

Investors pulled $134.5 billion from US equity mutual funds last year—$52 billion since September alone, when the market actually took off again. That’s fear, and can you blame people after everything that’s happened over the last few years?

Psychology may be the single most important factor in investors’ financial decisions. The best strategy in the world won’t work if it doesn’t survive a gut check. And I do think it’s important for everyone to have something invested in equities. So, why not own stocks that let you sleep at night more comfortably?

Carlson is a fan of Intel (INTC) and Microsoft (MSFT). Intel and Microsoft as solid, dividend-paying citizens? Who woulda thunk it back in the 1990s?

Actually, Intel is one of only four S&P 500 technology stocks that yield more than 3%, and dividend payouts comprise 40% of its free cash flow. Although the stock trades near its 52-week high, it changes hands at only 11 times projected 2012 earnings.

Meanwhile, “Microsoft has done quite well this year—it’s up 15% and hit a new 52-week high this year. We think it’s a pretty good value,” said Carlson. “Investors are looking for cheap tech stocks with growing dividend streams, and that fits it pretty well.”

The stock yields 2.6% after Microsoft hiked its dividend 20% last year. It has free cash flow of more than $20 billion a year, and over $50 billion in cash. It trades at only 11 times 2012 estimated earnings per share, and ten times next year’s forecasted EPS.

If you’re not into individual stocks, Carlson recommends the SPDR S&P Dividend ETF (SDY), an exchange traded fund that tracks the S&P High Yield Dividend Aristocrat index. That index comprises the highest-yielding stocks in the S&P Composite 1500 Index that have increased dividends every year for at least 25 consecutive years.

I like the Vanguard Dividend Appreciation ETF (VIG), which works on a similar concept. Full disclosure: I own its mutual fund cousin, Vanguard Dividend Growth (VDIGX).

As I said, stocks have come a long way in a short time. I’d wait for a correction to buy more. But if you’re looking for yield and equity exposure with less gut-wrenching volatility, dividend-paying stocks are the way to go—even in 2012.

Source: This Strategy Still Pays Big Dividends