As our population ages, more and more investors are focusing on retirement. With retirement comes a greater emphasis on investing for income and less emphasis on growth. However with the prospects for inflation looming in our futures, growth of income remains a serious and necessary investor consideration.
Investing in common stocks for dividends is generally considered a conservative strategy for prudent stock investors. However, not all dividend paying stocks meet the strictest definition of conservative or are considered safe. Also, it’s possible that higher current yield may not represent the best long-term investments. Dividend seeking investors should consider other factors as well. Factors such as quality, consistency, and current valuation are important to evaluate before investments are made.
To illustrate the importance of these points we will look at two sets of five companies with very different characteristics. We will start with five SMID (Small to Mid Cap) selections with current yields ranging from 5.1% to 6.4%. Based on yield alone they appear attractive candidates.
Fundamentals at a Glance
We will utilize our EDMP, Inc. F.A.S.T. Graphs™ (Fundamentals Analyzer Software Tool™) on each selection in order to achieve a more comprehensive view. Pay special attention to current valuation. The EDMP, Inc. F.A.S.T. Graphs™ offer potential investors an instantaneous perspective on a company's past operating performance and the total returns they generated.
Note that these 20 year charts only show data for every other year. The green area on the graphs represents earnings and does not always start at zero on each graph. The light blue area, shown above earnings, represents dividends, which are paid out of earnings. When a company reduced dividends, we have shaded the dividend cash flow table in red, and when the dividend has not been increased, we have shaded the period in yellow.
Five High-Yield SMIDs
Figures 1 a&b look at Eastgroup Properties (NYSE:EGP).
EGP is an equity real estate investment trust. As can be seen in Figure 1a, its current PE of 24.1 provides today's entry dividend yield of 5.1%. Historically speaking, this is an extremely low starting yield for this slow growing REIT. Furthermore, the dividend often exceeded EPS implying low dividend predictability.
Figure 1b calculates shareholder returns associated with Figure 1a. As the dividend cash flow table illustrates, double digit starting returns were typical. This implies that the current 5.1%, lower than typical yield, stems from current overvaluation. Inconsistent earnings growth has forced dividend cuts in 1992 and 2004. Nevertheless, total cash dividends from this REIT have been substantial. However, investors should consider the impact that current valuations would have on future dividend returns.
Figures 2 a&b look at UIL Holdings Corporation (UIL).
UIL is a typical slow-growing regulated utility. Nevertheless Figure 2a shows a lot of price volatility and inconsistent earnings performance. Inconsistent earnings performance has often led to a payout ratio in excess of 100%, which is obviously unsustainable long-term.
Figure 2b calculates the performance, including dividends, associated with Figure 2a. In the dividend cash flow table, note how inconsistent earnings resulted in the dividend remaining the same from 1997 through 2005 and after rising in 2006, the dividend was cut in 2007.
Figures 3 a&b look at National Retail Properties, Inc (NYSE:NNN).
NNN is a real estate investment trust. Earnings growth for this REIT has been very inconsistent and only averaged 2.2% since 1991. At 24.9 times earnings, it is currently trading at a very high valuation, based on historical norms. Consequently, as you will see in Figure 3b, the entry level dividend yield of 6.4% is half the norm.
Figure 3b calculates the performance, including dividends, associated with Figure 3a. NNN has been able to raise its dividend every year since 1991; however, the growth of those dividends has been very low, consistent with earnings growth. Nevertheless, total income from NNN has been strong.
Figures 4 a&b look at Urstadt Biddle Properties, Inc (NYSE:UBA).
UBA is a real estate investment trust specializing in commercial properties. As can be instantly gleaned from Figure 4a, earnings results for UBA are often erratic, mostly inconsistent, and have only averaged a 1.9% growth rate, since 1991.
Figure 4b calculates the performance, including dividends, associated with Figure 4a. Consistent with the erratic and inconsistent earnings seen in Figure 4a, the dividend record of UBA has been inconsistent and unreliable as well.
Figures 5 a&b look at Zenith National Insurance Corporation (ZNT).
ZNT is a holding company specializing in workers' compensation insurance. As Figure 5a clearly depicts, earnings performance has been both inconsistent and extreme. At 47.7 times earnings, valuation is high and possibly going higher as earnings have been collapsing under price.
Figure 5b calculates the performance, including dividends, associated with Figure 5a. From 1991 through 2003, ZNT paid the same dividend, even when earnings did not justify it. However, the company began increasing its dividend in 2004 as earning improved. It significantly increased the dividend in 2007 based on a surge of profitability. Current collapsing earnings should be a concern as payout ratio now exceeds 100%.
Summary of SMID group
Fast Graphs 1 a&b through 5 a&b provide a detailed and instantaneous perspective of the quality and historical operating performance of these five selections with above-average dividend yields. However, as the graphs and charts illustrate, yield is not always what it appears to be. Conservative investors seeking dividend income need to consider more than just current yield.
Five Stalwart Dividend Aristocrats
In Figures 6 a&b through 10 a&b, we present five dividend aristocrats through the lens of our EDMP, Inc. F.A.S.T. Graphs™. Each of these large cap stalwarts possess similar characteristics. The most important of which is a more consistent earnings growth rate of approximately 10% or better, which has allowed them to increase their dividends each year. The quality characteristics of this set of companies is clearly evident.
In contrast to the five SMID caps, each of these dividend aristocrats is selling at valuations that are low by historical standards. Therefore, instead of their entry level dividend yields being on the low side as seen with the SMID selections, these companies can be purchased with higher than normal starting yields. For brevity's sake, we will let each companies F.A.S.T. Graph™ speak for itself. As with the first five, we will produce the historical earnings correlated graph first, then the performance table associated with it next.
Figures 6 a&b look at Abbott Laboratories (NYSE:ABT).
Figures 7 a&b look at McGraw-Hill Companies, Inc (MHP).
Figures 8 a&b look at Sysco Corporation (NYSE:SYY).
Figures 9 a&b look at Automatic Data Processing (NASDAQ:ADP).
Figures 10 a&b look at Procter & Gamble Company (NYSE:PG).
For investors seeking income through dividends, current yield is not always the most important attribute to consider. Future yield and safety of principal should also be given careful examination. It should be interesting to note that the historical record of the five more conservative, lower yielding blue chips generally produced higher total returns. A few of the REITs did in fact generate more substantial total income streams; however, it can be argued that the level of risk taken was much greater.
For the conservative investors seeking a reliable future stream of growing dividend income and above-average capital appreciation, they might be best served by sticking with the stalwarts. As the old adage goes, “It's often better to be safe, than sorry.”
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Disclosure: Long ABT, SYY, ADP, PG at the time of writing.