Wednesday, June 5, 2013

Is the Dividend Craze Over?

I read an article from CNN, which discussed how the dividend craze was likely over. In general, I find articles that describe short-term movements of stock prices, and then adding terms like “dividend craze” to be extremely non-productive for dividend investors. The premise of the article was that some dividend stocks like utilities and consumer staples will have poor reception by investors going forward. Others such as banks and cyclical stocks, could do better as the economy improves. As an investor in the accumulation phase, I put money to work every month, but plan to hold for a few decades. This timeframe would encompass several economic cycles. This is why I have found that the best analysis I could do, is to research quality companies that could generate shareholder wealth for several decades to come, and avoid looking for stocks that can do well only in the current cycle.

I buy the stock in companies, which I believe will manage to increase earnings over time, and as a result they will be able to pay me a consistently higher dividend payment. The stock prices could fluctuate, but unless we get to see crazy valuations like the ones we saw in the early 2000s it makes little sense to sell them. At some point on the valuation scale, it does not make sense to overpay even for the best dividend stocks in the world. The near term drop in prices was probably caused by the fact that many stocks reached the high points of their reasonable valuations. To a long-term investor, entry price does matter, but holding on to a company with improving fundamentals is just as important.

Right now, companies such as Kimberly-Clark (KMB) and Coca-Cola (KO) are slightly overvalued trading above 20 times earnings. These are great companies however, which have sticky products that consumers buy repeatedly. I expect that these companies will keep growing over the next 20 -30 years, and expand their brands globally. At the end of the day, this growth will pay higher dividends for me to live off. This is why I plan on holding on to these stocks, even if they trade slightly above fair value right now.

Of course, if they fail to deliver results and are unable to maintain dividend payments at some point over the next 20 -30 years, I would likely part ways with them. In addition, if I get to situations where companies with high yields and low growth get bid up by the market to very low current yields, it might also be a time to part ways. For example, in March 2013 I sold all of my shares of Universal Health Realty Income Trusts (UHT), because the stock yielded 4%, but was growing distributions at a paltry 1%/year.

As an investor in the accumulation phase, who has to put money to work every month, I would be more than happy to buy quality merchandise at depressed prices. Unfortunately, I doubt that things would get so dire for quality dividend paying stocks. I do agree however, that in order to be successful, one does have to focus on buying the dividend growth stocks that are attractively valued. If I had to choose between Coca-Cola (KO) at 21 times earnings and Chevron (CVX) and 10 times earnings, I would always choose Chevron. This is where I agreed with the CNN article.

The article did mention that one of the likely selling triggers behind dividend stocks over the past two weeks might have been the increase in bond yields, and the expectations of further increases in treasury yields. The article didn't discuss this but at this stage, it still doesn't make much sense to buy bonds, despite the increase in 10 years Treasury yields from 1.50% to 2.20%. This is because long-term investors today who sell dividend stocks and buy bonds yielding 2.20% will likely be sorry in one decade. I could argue that we have a Fixed Income Craze, rather than a dividend craze.

Interest rates could and probably will increase over the next decade, as they are artificially kept low by the FED. However, the increase will likely be gradual over time as it would take a few years before we see the 4%- 5% in ten year treasuries. That means that investors buying Treasuries today are essentially locking themselves up to earn only 2.20% till maturity. If inflation and interest rates increase during that time, they will be worse off in 2023 than today. On the other hand, even if you purchase Coca-Cola (KO) today, chances are that ten years from now you will earn more in dividends, as the company would have higher earnings per share. This will protect the purchasing power of your dividend dollars.

Investors should have some fixed income allocation as part of prudent portfolio management. Right now, it doesn't make sense to add to bonds, but if you purchased them anywhere prior to 2010 for example you should be doing just fine by holding on to your bonds. For your stock allocation, you should be doing just fine holding on to your equities as well, assuming you know what you bought and why you bought it in the first place.

What stocks provide investors with is the potential for rising dividend income over time, which maintains the purchasing power of dividends. Before Wall Street became the casino that it is, where hedge funds and investment banks try to outmaneuver each other in the effort to earn a fraction of a cent per transaction, investors bought stocks for the dividend income.  I know that looking for perfection in investing will usually cost a lot in the long-term, which is why I would not sell Coca-Cola (KO) at 21 times earnings, and buy Wells-Fargo (WFC) instead. As a result, I plan on ignoring any mentions of dividend crazes, and hold on to my quality income stocks.

Full Disclosure: Long KMB, KO, CVX, Short WFC Puts

Relevant Articles:

Spring Cleaning My Income Portfolio, Part II
Does Fixed Income Allocation Make Sense for Dividend Investors
Dividend Stocks for Inflation Adjusted Income Streams
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- Carnival of Wealth Megadata Edition

9 comments:

  1. For me, the dividend craze will never be over! I love dividend investing and plan on sticking with the dividend growth strategy forever as I believe it is the best way to build my fortune!

    I find it best to ignore the noise and pay no attention to the articles that discuss crazes, fads and short term thinking. Like you, I prefer to think long term. I don't let short term factors influence my buy and sell decisions.

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  2. There are absolutely no reason to buy a Tbonds over a stock like KO right now.

    If one trusts the Gov to pay them back in ten year, he can certainly trust KO not to go bankrupt and still pay a healthy dividend.

    I truly wonder why investors seek for bonds right now; it's like calling inflation to shoot them dead for the next decade. Strange philosophy for someone who wants to avoid risk, isn't?

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  3. Colgate-Palmolive (CL) had a stock split. Any idea why?

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  4. Dan,

    We are on the same boat in thinking that one should ignore short term noise. Unfortunately, CNN, CNBC and others need to fill in their pages/programming with something.

    Mike,

    Bonds have been an underloved asset class for the past 5 years. The only scenario where bonds make sense today is if you believe the US will be like Japan was between 1990 and 2012. Another reason could be if we experience the next great depression. My fixed income allocation is in cash and CD's, but it's below 5%. I would like to bring it up to 10%, but the deals I find in the stock market are better for me.

    Squeezer,

    Companies split their stocks in order to make them more accessible for individual investors to buy. For some investors, it is easier to buy 200 shares at $60/share, than buy 100 shares at $120/share.

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  5. Ya it's really getting old when people on CNBC are saying dividend stocks are over. What? Really ? Nothing has changed with my dividend stocks other than a few have increased their dividends. How are things over exactly ? From my perspective things are only going to get better as I hold these stocks. Maybe if bonds start yielding 10% over night then I can see this reaction but until then these analysts need to can it.

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  6. I have to admit that it's a little scary to hear these reports as a new Dividend investor. I'm holding on to my stocks, mostly because it would cost too much to get rid of them right now anyway. Just hoping everything shakes out in the long term. Love your site!

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  7. Hi all - how does all of this apply to Bond index funds? I am a relatively new DGI, but I still have money in my 401(k) in some mutual funds, including a Vanguard Total Bond index fund. Should I hold onto it, but stop contributing to it? Are any new shares I buy in a total bond fund, locking me into the low rates of today for the next few years? Any clarity on this would be greatly appreciated. Thanks.

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  8. We should be grateful for those kinds of reports, because scared investors dump their shares and drive the price down to a better level for us to buy.

    If you buy quality (stable businesses that grow revenues and grow dividends), diversify, and have a long-term approach, you'll be just fine.

    Thanks as always, DGI!

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  9. @Anon

    As with anything there are trade offs to owning either individual bonds (in a ladder) or bond funds.

    I dont necessarily agree with this authors conclusions but it will atleast give you an example of the tradeoffs that you can then go off and do your own research.

    http://janebryantquinn.com/2011/01/7-reasons-why-bond-ladders-are-bad-for-investors/

    I'm 30 at the moment so i really see no need to have anything more than 5-10% in bonds at this point in my life.

    ReplyDelete

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