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Dividend Investing
Building and managing a dividend portfolio starts with setting objectives for yield and growth, finding securities that meet your objectives, tracking your progress, and pruning and improving your portfolio as conditions warrant. Peters: “More dividend yield typically means less dividend growth, but I do not settle for anything less than inflation.”
Screening for dividends is basically a process of elimination, according to Peters. He gives six important rules that do not work for a dividend strategy:
- Stocks that do not pay dividends at all
- Stocks with less than 3% dividend yield
- Companies with no identifiable competitive advantages
- Companies with high leverage
- Companies with high earnings volatility
- Companies with negative corporate governance factors
Basic parameters at screening for dividends are companies with a market capitalisation of $500 million or greater (£320 million or greater). “Size correlates somewhat with financial and competitive strength”, says Peters. Morningstar’s economic moat rating should be “Narrow” or “Wide” and the uncertainty rating of the fair value estimate should be “Low” or “Medium”. Peters: “Sustainable long-term competitive advantages underpin both dividend safety and dividend growth. And while Morningstar’s uncertainty ratings are not specifically tied to dividend risks, our estimated fair values with ‘High’ or ‘Very high’ ratings are red flags.” The current dividend yield should generally be 3% or greater.
“Maximising current dividend income is a fine strategy, but only with some constraints”, warns the dividend strategist. “Find appropriate measures of dividend safety, require that dividend growth should at least match inflation, and provide adequate diversification across companies and industries.”
About diversification: do not put all your eggs in one basket. Peters' guidelines are to have 12-20 individual stock holdings, exposure to at least 4-5 distinct sectors of the economy, and be sure your portfolio can pass the ‘sleep at night rule’. That is a level of risk and volatility that the investor can tolerate even during periods of market and economic turbulence.
When should a dividend investor buy or sell stocks? One should sell when the dividend looks shaky and the risk is not yet fully discounted in the price of the stock, when the dividend growth repeatedly trails ones expectations, or when the stock price goes so high that the dividend can not be expected to drive a good total return from that point forward.
An opportunity to buy is when a new stock offers more yield than an existing holding with the same dividend growth, more dividend growth with the same yield, or better fundamental quality with similar total-return prospects.
Safety
With the current volatility in the stock markets, people look for safety, and dividends are one of the few attractive areas left to get a good cash income. “Dividend investing is not a fad and has nothing to do with being old or retired”, gives Peters as a final thought. “It is essential to take a long-term view and focus on dividend safety, dividend growth and total returns. Then, let the companies do the heavy lifting in earning your returns.”
Dividend Sector Tour
Below are some interesting international dividend stocks in several sectors. It can generally be said that companies around the globe tend to pay out larger dividends than U.S. companies, which often focus more on share repurchases. However, given the size of the U.S. market, even there it is not hard to find decent yield.
Utilities
National Grid
Terms of critical regulatory proceedings in the U.K. are getting clearer; long term dividend growth likely to exceed inflation
Peters: “The utilities sector has become expensive, but there are still a few cases where total-return prospects remain decent. I overwhelmingly favour fully- or almost fully-regulated operations.”
Telecom
AT&T
Its planned purchase of T-Mobile is likely dead, but with 26 consecutive years of dividend growth to date, odds are still good that the dividend will continue to rise.
Peters: “The plain old telephone services are in secular decline and should de handled with great care. AT&T benefits from much broader diversification than some of the sector's higher-yielding stocks.”
Energy
Royal Dutch Shell
Higher payout ratio than U.S. peers generates attractive yield for this giant, well-diversified energy firm.
Chevron
An extra dividend hike in October underscores the firm's commitment to dividend as well as the long-term growth of oil and gas production
Peters: “While most small E&P firms (exploration and production) in the U.S. eschew dividends in favour of exploration, the super majors present an interesting option for long-term investors.”
Consumer defensive
Philip Morris International
Giant dividend hike of 20% in 2011 is too much to expect repeatedly, but underscores long-term growth story.
Diageo
Management recently raised its medium-term growth outlook on improving internal growth and cost cuts, which should lead to enhanced dividend increases.
Procter & Gamble
Low volume growth plus inflation and share buybacks should drive healthy long-term dividend growth.
Peters: “These are classic defensive stocks for classic defensive investors.”
Healthcare
Abbott Laboratories
Planned spinoff of branded drugs unit is not necessarily a positive, but firm still provides superior growth prospects relative to peers.
Johnson & Johnson
Consumer product recalls over the past few years took a toll on management's credibility, but at least the dividend looks very safe and the outlook for earnings growth is improving.
Peters: “Healthcare is the rare sector where lower-yielding stocks tend to be more attractive. The industry as a whole is now falling off the patent cliff and retained earnings may fund acquisitions and additional research expenditures rather than dividend increases.”
Banks
Wells Fargo
Despite a dividend cut in 2009, this bank's long-run earning power is higher now than it was before the crisis. The dividend has already started to rebound and has plenty of upside from here.
Peters: “The banks broke the hearts of dividend investors everywhere. All large U.S. banks eventually slashed their payouts. But if future growth potential is lower amid slow economic growth, deleveraging and more aggressive regulation, more generous dividends will be key to continue attracting capital to the sector.
Industrials
General Electric
As revenues, profitability continue to rebound, another dividend hike is likely at year-end 2011.
Peters: “Outside traditional high pay-out sectors, meaningful yields can tell us a lot about the company and its attitude toward shareholders. I believe these companies will reward investors over time, and vice versa.”
Income Bellwethers
Below is a watchlist of higher yielding stocks (with a focus on European stocks and global stocks that are not consider too exotic, from a European point of view) that reside on Peters' "Income Bellwethers" watchlist.
3M
It's easy to be impressed by 3M's prowess as an innovator, but a policy where dividend hikes are targeted to run at only half the rate of EPS growth is unimpressive.
Coca-Cola
Asset swap with Coca-Cola Enterprises shifted mix back to North America where growth is modest
Exxon Mobil
Financial strength and operational excellence give ExxonMobil a meaningful edge versus rivals, but dividend takes a backseat to share repurchases.
HSBC
Famous for frugality and efficiency, became first global bank to raise its dividend in early 2011. Given the breadth of the firm's operations, however, it's important to keep an eye on speculative imbalances (particularly in Asian real estate).
McDonald’s
The company's shift in focus from growth to profitability a few years back now pays large dividends.
Nestle
World’s biggest food and beverage firm, may also be the best with large exposure to emerging economies.
Novartis
See dividend rising at 5-6% annual pace over the long run as well-diversified businesses benefit from rising spending on healthcare worldwide.
Unilever
First-mover advantages in developing economies offset by legacy of extreme decentralisation. Restructuring is helping, though rising commodity costs are an ongoing challenge.
Vodafone
In addition to impressive emerging markets opportunities, 45%-owned Verizon Wireless is starting to return cash to Verizon and Vodafone, which improves the outlook for dividend growth at both firms.
