On April 8th of 2016, Procter & Gamble (NYSE:PG) announced that it had increased its dividend. This marks the 126th straight year of paying a dividend and 60th consecutive year of making a higher payment. That's the good news.
The bad news, in the eyes of many income investors, is that the quarterly payout went from $0.6629 to $0.6695 - just a 1% increase. Here's a look at the payout growth in recent years:
2004 = 9.9%
2005 = 12%
2006 = 10.7%
2007 = 12.9%
2008 = 14.3%
2009 = 10%
2010 = 9.5%
2011 = 9%
2012 = 7%
2013 = 7%
2014 = 7%
2015 = 3%
2016 = 1%
You can see why many income investors are treating the recent dividend growth as a cause for concern. After years of double-digit or high single-digit growth, the last two payout increases have been underwhelming. Still, an increase is an increase and the six-decade payout boost streak goes on.
It should also be noted that the payout ratio has gone from around 40% in 2004, all the way up closer to 70% today. So while part of the past dividend increases has been fueled by earnings growth, a good portion of the higher rates are a result of payout expansion as well. Incidentally, that's why considering a payout ratio can be important - a lower one leaves room for dividend growth that outpaces earnings growth. Alternatively, as we've seen recently, companies tend to get more cautious as you approach the higher end of range.
The payout boost is disappointing to income investors for obvious reasons - your income doesn't go up as much as you thought it might. Yet I'd like to point out a number of important counterpoints.
First, it's still an increase. Perhaps not to your liking, but it sure beats a stagnant payout of a dividend cut. Second, if you've held shares for a long time you probably saw something like this coming. Large companies with historic dividend increase streaks usually don't want to test that history by getting ahead of itself with the payout ratio. Often this means bumping it up until it its half or two-thirds of profits, before you start seeing payout growth in line with earnings growth. The solid growth experienced in the earlier part of the decade is now experiencing the opposite effect as the company transitions.
Moreover, and a lot of people don't like to hear this, but it provides a bit of prudence. The same type of thing is being forced upon banks with lower dividend payout ratios. The income investor would like to see more income, but I'd contend that the long-term sustainability of the payout is just as important. Continuing to increase the dividend by 10%, as an example, and then having to cut this mark down the line would not be a prudent move in my view.
Beyond those things, there's another aspect to being "disappointed" with the dividend increase that many do not consider. You don't have to be an idle spectator in this process. I'll show you what I mean.
Procter & Gamble increased its quarterly dividend by $0.0066 or $0.0264 on an annual basis. Many people suggest that this inadequate (and indeed, some have indicated that they are thinking about divesting their stake based on this factor alone). Yet let's think about what would have been acceptable. I'd contend a 7% increase would have made a lot of dividend investors happy.
If Procter & Gamble instead increased its dividend by 7%, it would now be paying a $0.7093 quarterly dividend. I would round to $0.71, but the company has a habit of not rounding its payment off. That's $0.0398 higher than what actually occurred or just under 16 cents on an annual basis.
Think about that. The difference between being a disgruntled income investor thinking about selling your stake and a happy-to-hold lifetime owner in this scenario is 16 cents per share.
Furthermore, you'd not forced into the decision or simply holding or selling. You can "manufacture" a bit of additional income by making an agreement.
As I write this shares of Procter & Gamble trade hands around $83. The January 20th 2017 call option with a strike price of $97.50 last transacted at a price of $0.24. Let's make the example simple and call it $0.16 after fees. This means that if you were willing to sell your shares at a price of $97.50 in the next nine months, you would collect that extra $0.16 per share ($16 total) that you "missed out on" by not receiving a 7% dividend increase.
Of course the option premium could be taxed differently than your dividend payments, and there are multiple outcomes possible, but the idea is that you're not "stuck" with whatever income a firm happens to provide you with.
If you were to make this agreement, one of two things happens: either the option is exercised or it is not. If the option is not exercised you would continue to own shares and collect the dividend payment as you normally would. The only difference is that because of the upfront option premium your cash flow from holding the shares would be about 7% higher than the previous year instead of 1% higher for the typical buy-and-hold investor. Granted you may not be able to accomplish this every year, but it shows the difference between "disgruntled" and "content" quite well.
If the option were exercised, you would receive proceeds of $9,750 (less frictional expenses) for your 100 shares. You'd still have the upfront option premium and may or may not also collect dividends based on when the option happens to be exercised. Without considering dividends, your return would be about 17.4%. The risk is that shares move materially higher and you're "stuck" selling at $97.50. Of course seeing a 17% return in the next nine months isn't exactly a great tragedy either.
You can moderately increase your cash flow by making an agreement to sell shares at a much higher price in the future. Alternatively, you could also think about materially increasing your cash flow by making agreements closer to the current price. Here's a range of possibilities using the same expiration date as above:
In the table above the strike price represents the price at which you'd be happy to sell shares. The "net" premium takes the most recent transaction price less $0.08 for fees - your costs may be higher or lower. The premium yield details the amount of upfront cash flow that you would receive for making the agreement. The "capped gain" indicates the maximum gain that you are agreeing to, prior to considering any dividends received.
It's not talked about as often, but instead of a 1% income boost you have the potential for increasing your income by 20%+ this year by agreeing to sell at a price of say $92.50. If the call option is not exercised you collect your dividend payments and the option premium nicely supplements this. If the option is exercised you have the hassle of having to reallocate capital (and perhaps the psychological test of seeing a higher price) but you still would have a collected nice return.
In short, many investors were not impressed by Procter & Gamble's most recent dividend increase. And to be sure, for those looking for ever higher income a 1% raise isn't much to get excited about. Yet you don't have to be a passive onlooker in this development. You can both hold shares and generate more cash flow than the dividend alone. It's paramount to be content with either side of the agreements, but it stands that options to boost your cash flow are literally available to you.
Disclosure: I am/we are long PG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.