In the 0% interest-rate world of Ben Bernanke, the 3% dividend yield is king.
When a 2-year Treasury note yields 0.22% and a two-year CD pays 0.85%, it’s not surprising that savers and investors are eager to snap up anything with a higher yield.
That’s got an upside—stocks that pay 3% or more have shown big gains in price as dividend-hungry investors have bought the shares. Intel (INTC), for example, which paid a 3% dividend at the end of 2010, returned 19.03% in 2011 (in price appreciation and dividends.)
And it’s got a downside—as investors pile into a stock yielding 3% or more, the dividend yield goes down as the price goes up—even if the company increases its dividend payout. Intel paid out 78 cents a share in dividends in 2011 versus 63 cents in 2010, but thanks to the climb in the stock’s price, the yield now—on February 1, 2012–of 2.94% is less than the 3% yield in December 2010.
Companies recognize this hunger and, as I wrote in my November 25 post http://jubakpicks.com/2011/11/25/companies-re-emphasize-dividends-and-it-couldnt-come-at-a-better-time/ , they’re aggressively raising their dividends because they realize that in the current low-yield world it’s an extremely effective way to support their stock price. Investors right now would rather get a higher dividend than a share buyback. This has led companies to shockingly hefty dividend increases. One recent example is Mattel (MAT), which lifted its dividend by 35% on January 31. A full year’s pay out at the new rate works out to a yield of 4% on the January 31 closing price even after the shares jumped 5% in price on the news.
I don’t think the trend pushing up the price of stocks yielding 3% or more is about to come to a quick end. At its January 25 meeting the Federal Reserve’s Open Market Committee said it would keep short-term interest rates at their current exceptionally low level—I guess 0% counts as exceptionally low—until the end of 2014. That’s a big extension of the Fed’s previous guidance for interest rates at this level until mid 2013.
Which sets savers and investors an interesting problem. We all want higher yields and we certainly don’t mind cashing in on any price appreciation. But the appreciation in share prices constantly pushes the yield down on these stocks. That’s not a problem for investors who already own shares. They’ve locked in their yield when they bought. But it is a problem for investors with new money as yesterday’s high dividend stock turns into tomorrow’s stock with a mediocre yield.
And settling for a declining yield because we locked in a good yield when we bought our shares a year or two or three ago strikes me as passing up one of the best things about the current dividend craze. Because many companies right now see a higher than 3% yield as the best way to support their share price in a sometimes difficult market, many companies are working hard at raising their dividend payout fast enough to keep pace with their rising share prices. The goal is to add enough to the dividend payout every year (or even every quarter) to keep that yield above 3% even if the share price is climbing. So, for example, Intel, which saw its yield slip below 3% as its share price climbed in the first half of 2011, upped its quarterly dividend to 21 cents from 18.12 cents with the August quarter.
Of course, not every company has the cash to do that—or a management that’s committed to increasing the dividend at that pace. But as a saver or investor in this financial environment, you’d sure like to have more of those stocks in your dividend income portfolio rather than less.
So that’s why I’m going to do a fine-tuning of my Dividend Income Portfolio http://jubakpicks.com/jubak-dividend-income-portfolio/ today. This won’t be my annual full-scale performance report and portfolio over haul. I’ll keep that for May as usual. But I have gone through the portfolio looking for companies that I think might fall behind in the dividend race and I’ve replaced three of the picks in the portfolio that concern me on that basis with new dividend plays.
What stocks go?
Just three for right now.
Drug company Abbott Laboratories (ABT). When the company reported earnings on January 25, it announced that it would resume its share repurchase program, but it left the dividend at 48 cents a share, where it’s been since April 2011. (The last quarterly dividend was paid to shareholders of record as of January 13.) My suspicion is that the company is wrapped up in plans to split into two companies by the end of 2012. I don’t think investors can expect a significant dividend increase before the split. The current dividend yield of 3.54% will stay above 3% only as long as the stock doesn’t appreciate significantly. That’s not the combination I’m looking for in this dividend-happy stock market.
Drug company Merck (MRK). Merck increased its quarterly dividend to 42 cents a share from 38 cents in the last quarter of 2011. That pushed the stock’s current yield on a 2012 dividend of $1.68 to 4.3% on the February 1 price of $38.63. But I think that’s Merck’s last dividend increase for 2012. In August 2012 the company loses patent protection on allergy drug Singulair and Singulair represents 10% of Merck’s sales. The company has a solid pipeline of new drugs that should be able to make up for the loss of Singulair in 2013, but for 2012 there’s a good chance the company will report a single-digit decline in sales for 2012. That’s the kind of uncertainty that keeps a board of directors from raising dividends.
Timber and wood products REIT Potlatch (PCH). The current depression in the housing industry makes these tough times for timber companies and Potlatch has actually cut its dividend payout from $2.04 in 2010 to $1.84 in 2011. Dividends are projected to drop even lower in 2012 since the company reduced its quarterly payout to 31 cents a share in December from the previous 51 cents. That brings the projected yield for 2012 down to 4.08% from the current trailing dividend yield of 6.06%. That’s the wrong direction and although I think we’re starting to see signs of a bottom in home building, I don’t think the recovery will be quick enough to add to Potlatch’s dividend payout in 2012.
My gains on Potlatch since I added these shares to the Dividend Income portfolio on December 9, 2008 are 37.65% (plus an original dividend yield of 7.2%) My gains on Abbott Laboratories of 3.3% and on Merck of 6.5% are much smaller since I only added these stocks to the Dividend Income portfolio on May 6, 2011. The original yields on those two stocks were 3.4% and 4.15%, respectively.
For my May annual revision I’m keeping my eye on two other stocks currently in the portfolio, French oil company Total (TOT) and U.S. coal-mining master limited partnership Penn Virginia Resource Partners (PVR). Both still have projected yields for 2012 high enough—4.73% and 7.83%, respectively—to make them tough to replace. But I worry about the pressures that falling energy demand in a slowing global economy are putting on cash flow.
What to replace them with? Why companies that are showing good prospects for future earnings growth that will lead to higher dividends, of course. (And that are already paying out a 3%-plus yield.)
Pipeline master limited partnership Kinder Morgan Energy Partners (KMP). The partnership paid $4.32 a unit in 2010 and $4.58 in 2011 and thanks to new pipelines serving the U.S. energy boom and the likely drop down of assets from general partner Kinder Morgan’s (KMI) acquisition of El Paso (EP), I think the partnership will see growing cash flows that it can pass through to unit holders. (Master limited partnerships aren’t suitable for tax-sheltered retirement accounts in all circumstances. Please check with your accountant to see if a purchase might put you over the income limits for this kind of account.) The current yield on these units was 5.38% on February 1.
The ADRs (American Depositary Receipts) of Australia’s Westpac Banking (WBK). Westpac grew dividends to $8.06 in 2011 from $6.41 in 2010. The current trailing 12-month yield is 7.12%. Like many overseas companies, Westpac doesn’t pay quarterly dividends instead making its payouts twice a year in May and November. Australia’s banking market is divided up among just four major banks, which gives Westpac important advantages of scale (and a lack of outside competition.) The biggest worry is the Australian housing market. I think tight underwriting and low loan to valuation mortgages make this a very different market from that in the United States or the United Kingdom. But if you’re worried about an Australian housing bubble, this isn’t the dividend stock for you. (Westpac Banking is already a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )
Industrial equipment powerhouse General Electric (GE). General Electric increased its dividend twice in 2011 after upping it twice in 2010. The December increase brought the projected 2012 yield to 3.62%. That’s not especially juicy, but I’m betting that General Electric will continue to add to its dividend payout in 2012. In the company’s fourth quarter conference call CFO Keith Sherin told investors not to expect that the company would use all of its current $12 billion in excess cash on dividend payouts. The company expects to keep $8 billion in reserve and then use the other $4 billion for acquisitions and dividends. Add in cash flow from operations and there’s clearly enough in the vault to fund another couple of dividend increases in 2012. Especially if the U.S. economy keeps chugging along at its surprisingly strong (if modest) pace.
I’ll be making these adds and drops to my Dividend Income portfolio over the next few days.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund owned shares of Abbott Laboratories and Westpac Banking as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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