Dividend growth investing has become quite a popular topic over the past year or two. As Treasury yields still hover in the vicinity of all-time lows and with corporate bond spreads having narrowed significantly since last fall, it would not be surprising to see investors continue to flock towards dividend paying companies with stable businesses and the potential to grow their payouts over time. With this in mind, I investigated some of the recent trends, with respect to dividend payouts, from a sector perspective. I also sought sector-specific information relating to popular metrics investors use to gauge whether stocks are cheap or expensive. Presented below are some of the results:
One hundred companies in the S&P 500 (SPY) have announced dividend increases thus far in 2012. Among the dividend raisers, 54 increased their payouts by ten percent or more. Four companies actually increased their dividends by one hundred percent or more. Fidelity National Information Services (FIS) increased its quarterly dividend from 5 cents per share to 20 cents per share. Gannett (GCI) increased its quarterly dividend from 8 cents per share to 20 cents per share. Macy's (M) gave its shareholders a raise from 10 cents to 20 cents per share on a quarterly basis, and Mastercard (MA) followed suit with a doubling of its quarterly payout from 15 cents to 30 cents per share.
In terms of the breakdown by sector, nine of the S&P 500's ten sectors have already had companies raise dividends, with Telecommunication Services (IYZ) being the one exception. Below, you will find a table outlining the number of companies in each sector announcing dividend increases in January or February of this year. Keep in mind that seasonality could be a factor contributing to why certain sectors are outperforming others this early in the year. Typically, companies that increase dividends every year do so at the same time of year.
Number of Companies Announcing Dividend Increases
Not only has telecom not had any dividend increase announcements in 2012 (although some telecom companies are expected to announce increases later this year), it is also the second worst performer among the ten S&P 500 sectors in terms of price appreciation. Furthermore, telecom has the second lowest operating margins among the sectors for the fourth quarter 2011 earnings reporting season. Its 4.25% operating margins are less than half the S&P 500's 8.66% for the quarter. As if all that isn't bad enough, based on 2012 estimates, telecom also has the highest forward price-to-earnings ratio (18.06) of the ten S&P 500 sectors and is only expected to grow earnings at a 4.67% clip in 2012.
With that said, as the following table shows, telecom does lead the way in one category, dividend yield.
Dividend Yield by Sector
Through February 2012
For dividend growth investors, telecom probably isn't the space you want to be targeting if you have new money to put to work. Given everything outlined in the paragraph above, if you are looking to buy companies with the ability to strongly increase dividends in the future, there are better places to look. However, for investors who are happy with the current yields, regardless of the potential for weak dividend growth and the potential for the sector to get cheaper from a price perspective, telecom's 5.61% sector dividend is likely enticing.
Another sector dividend-seeking investors often target is the Utilities (XLU). This sector is the worst performer thus far in 2012, and despite thirteen utilities companies announcing dividend increases year-to-date, as a whole, the dividend increases have been less than impressive. Just two of the thirteen increases, those from Sempra Energy (SRE) and CMS Energy (CMS), were greater than 10%. Seven of the thirteen companies announced increases of 3.65% or less. Furthermore, 2012 estimates for the Utilities sector are forecasting earnings to decline by 0.88%. Although the sector sports a 14.3 forward P/E (based on 2012 estimates), making it cheaper than telecom on a P/E basis, it's tough to gauge whether the earnings decline and the fact that the Utilities already saw a multiple expansion of 13.78% in 2011 will prevent further multiple expansion. Without multiple expansion, new money flowing into the sector will struggle to find much upside in terms of price appreciation.
Therefore, investors wanting to put money into this sector will have to ask themselves whether a 4.27% dividend yield is enough to compensate for the risk of no earnings growth, weak dividend growth, and a possible reversal of last year's multiple expansion. For investors looking for the most bang for their buck, focusing on individual companies rather than sector ETFs will be the way to go. For investors focusing on income only, caring less about price appreciation/depreciation, sector-wide ETFs should do.
Moving on to the next sector, it's also hard to consider Consumer Staples cheap. The sector currently has a 15.1 forward P/E (based on 2012 earnings estimates), a 2.68 price-to-earnings growth rate, and at 3%, a lower dividend yield than the previously discussed sectors. However, there are a few things this sector has going for it. First, it is expected to grow faster in 2012 than the top two dividend yielding sectors (Telecommunications and Utilities) with 5.63% earnings growth. Second, the recently announced dividend hikes are impressive. Of the seven companies thus far announcing dividend increases through February 29, not one was less than 5.71%, and three of the seven were greater than 10%. Third, this sector is full of very well-known, time-tested companies such as Kimberly-Clark (KMB), Hershey (HSY), and Coca-Cola (KO). Having a strong brand can often get you a little leeway with investors if things don't go exactly as planned. Therefore, Consumer Staples and its 15.1 P/E combined with its many strong brands, solid dividend growth, and current 3.0% dividend yield seems like a better spot to focus one's efforts than Telecommunication Services or Utilities.
Industrials (XLI), Health Care (XLV), and Materials (XLB) are three sectors with dividend yields generally in the range of the 10-year Treasury's current tax-equivalent yields (depends on your state and local tax rates).
Year-to-date, the Industrials sector has shown a strong propensity to increase dividends. Not only is the sector second in terms of the number of dividend increases, but the strength of the increases was widespread with ten of the seventeen companies increasing their payout by more than 9%. In fact, only one company, Pitney Bowes (PBI), announced a dividend increase of less than 5%. The sector forward P/E for Industrials is 13.51 with 13.66% earnings growth expected. If you think this sector can live up to or beat expectations, this might be the place to be. One caveat to keep in mind, the Industrials sector has been experiencing multiple contraction throughout the bull market that began in 2009. While you've likely heard of "Don't catch a falling knife" when it comes to the nominal prices of stocks, also keep that in mind when it comes to P/E ratios. Falling P/E ratios have the ability to offset a decent amount of earnings growth. The ultimate question for investors in Industrials should be, "Where is the bottom for the P/E ratio?"
In the Health Care sector, WellPoint (WLP), St. Jude Medical (STJ), and Abbott Laboratories (ABT) have announced dividend increases in 2012. The increases were 15.00%, 9.52%, and 6.25% respectively. Health Care's 2012 forward P/E is 12.10 with 11.54% earnings growth expected. Given that this sector's lowest P/E come year end, dating back to 2008, was 12.62, it would be reasonable to expect upside price potential should earnings live up to expectations. However, the question then becomes whether the combination of a 2.33% yield with upside price potential, versus some of the higher yields in sectors with lower price potential, is a choice worth making.
The Materials sector has had six dividend increase announcements in 2012. Four of those increases were 10% or greater, the largest of which was Ball Corp.'s (BLL) 42.86% increase from seven cents per share to ten cents per share on a quarterly basis. Similar to the Industrials, the Materials sector has been experiencing multiple contraction throughout the three year bull market. Given that its forward P/E is actually higher than its 2011 P/E despite 8.9% expected EPS growth, it is possible the Materials have largely priced in this year's growth expectations, unless of course you believe the multiple contraction has ended and will now reverse course.
If you're a dividend investor looking for yields of less than 2% on a sector-wide basis, Energy (XLE), Financials (XLF), Consumer Discretionary (XLY), and Information Technology (XLK) are the places to look. If I were venturing into these sectors, I would be doing so on an individual stock basis. Despite the ultra-low yields, these four sectors have shown strength in terms of the number of dividend increase announcements. Also, on the whole, the strength of the increases was impressive. For example, in Consumer Discretionary, eleven of the nineteen companies that announced dividend increases did so by 20% or more. A further six companies announced dividend increases of 10% or more. Among the large dividend increases was that of Comcast (CMCSA). If you're one of the Comcast customers watching your monthly bill go up every year, rest assured that the "other investments" or "business costs" cited in the "your rates are going up" letters you receive in the mail are being enjoyed by shareholders to the tune of a 44.44% dividend increase (up 160% since 2009).
In the Energy sector, seven of the nine dividend announcements were for payout increases of 10% or more. Eight of the ten increases in Information Technology were also of 10% or more. The Financials were more spread out in terms of the strength of the dividend increases, ranging from 2.13% to 50% (and a whole lot in between). When looking at P/Es and earnings growth, all four sectors currently have 2012 forward P/Es that are higher than 2011's closing P/Es. This is true despite earnings growth expected from all four sectors. When the forward P/E is higher than the trailing P/E and forward earnings estimates are also higher than trailing earnings, it sends the signal that prices have been going higher. This should make investors question how much of the future earnings expectations have already been priced into the market. From the dividend investor's perspective, if you care at all about capital appreciation, be careful when looking at these sectors. Stock-specific selection will be important.
In closing, I would like to note that for a dividend investor who is not concerned about capital appreciation and more concerned about current income levels rather than dividend growth, keep an eye on the corporate bond market. Despite the fact that benchmark Treasury yields remain low by historical standards, corporate bond spreads often fluctuate, sometimes widely, with changes in the perception of the outlook for the economy. Consider making a list of senior notes from the lower investment grade, higher non-investment grade realm that you wouldn't mind owning the next time spreads widen (like they did last fall). A diversified, held-to-maturity portfolio of higher yielding corporate bonds could be a nice complement to a portfolio dominated by dividend paying equities. You might be surprised at what you will find a little further up the capital structure.