Thomas Forsha is clearly enthused on the topic of dividend investing, and seeking out high-yielding stock in particular. He leaves his Morningstar Investment Conference audience with a comprehensive list of factors to take into consideration when seeking dividends and building a dividend portfolio.
Before we go into Forsha's top tips, a few cavaets. The River Road manager, a subadvisor to Aviva Investors, warns that an attractive dividend does not always make an attractive investment. He also says dividend investors need to be "very, very cautious" given the 'hot topic' status of dividend investing at present.
These factors are crucial considerations when assessing a dividend-paying stock, according to Forsha:
- does the company raise its dividend regularly?
- is the payout ratio sustainable?
- is the company financially strong?
- does the company's management emphasise the importance of the dividend?
- do the shares seem reasonably priced?
When it comes to building a dividend portfolio, diversification is just as important is it is elsewhere. Forsha outlines a model portfolio in which broadly a third of assets are held in 'core' dividend stocks (those yielding 2-4%), a third in high alpha dividend stocks (yielding 3-6%), and a third in high yield stocks (5%+ yield). But in his role as an asset manager, Forsha notes that it's very important to be able to respond to broader developments, thus this model portfolio's current asset allocation is split 60% on core, 35% on high alpha and 5% on high yield. Why? Because the main focus has always got to be on total return, Forsha says, on capital gains rather than getting carried away by yield.
So where to find these reliable, high-yielding companies? Data on the US all-cap stock market shows small-caps tend to have up to 50% higher yields and, of course, there are a lot more small-cap stocks than there are large-caps. This goes against the traditional wisdom that it's the large-cap stocks that are the reliable dividend payers.
Continuing on the small-cap theme, a financial adviser in the audience asks Forsha whether their high-yield tendencies are related to the company's executive structure. "Absolutely, you've got it," Forsha replies before expanding on his answer to explain that directors of smaller companies often have interests aligned with their investors' as paying dividends is one of the ways that the directors pay themselves.
In certain cases, a company may choose to pay a dividend for the 'wrong' reasons, but in general when a company pays a dividend it's a sign of considerable conviction in the outlook--a company that pays a dividend by-and-large will have real earnings, solid balance sheets, good brands and the benefits of an economic moat. Further, there's a ratchet effect when it comes to dividends, Forsha says, whereby once a dividend has been paid, or even increased, companies are loathe to decrease them given the negative effect it would have on stock sentiment.
But are dividend stocks in a bubble? Forsha says that, to a certain extent, dividend stocks are self-regulating: as the stock price rises, the yield falls. Having said that, Forsha reiterates his point that dividends are certainly a hot topic at present and when everyone's talking about the same thing it's time to take caution.
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