Even though economists and pundits alike continue to tell us that the U.S. economy is recovering, it's difficult to believe. Unemployment remains sky-high, and a downbeat May retail sales report suddenly has people whispering the dreaded "D" word: double-dip recession. Worse yet, the stock market, which typically foreshadows the direction of the economy by a few months, has fallen roughly 8% in the past month and a half. It's no wonder folks are getting jittery. However, at least one measure of our economic health is positive and gaining traction.
Things are looking up
During the depths of the recent economic crisis, many companies cut their dividends in an attempt to conserve cash in light of widespread uncertainty. But as the economy has recovered, and managers feel more confident in their firms' future prospects, companies have been raising, or at the very least maintaining, their current dividend commitments. So far in 2010, 135 companies have raised or reinstated dividend payments, while only two have cut them.
In a recent interview with CNBC, John Dorfman of the Dorfman Value Fund explained why this is a positive omen for future profits:
Dividends are a sincerity barometer. Boards aren't going to raise them if they think they're going to turn around and cut them…. So it's a sign that earnings are sustainable.
And while the economy faces a boatload of structural challenges going forward, I agree that this is a positive commentary on both corporate health and future opportunities in the stock market.
Why it pays to pay out
Investors once tended to shun dividend-paying stocks in favor of red-hot growth stocks that seemed to triple overnight. But today, Fools should reexamine their affinity for dividend producers. Over the long run, stocks that pay dividends have flat-out outperformed those that don't.
According to data from Franklin Templeton, over the past 30 years:
- Dividend cutters and eliminators posted an annualized loss of 1.28%.
- Non-dividend-paying stocks clocked in with a 1.34% positive return.
- Dividend payers with no change saw a 7.15% increase.
- Dividend growers topped the list with a 9.33% annualized gain.
Furthermore, the time may be ripe for dividend payers to take the stage. Historical data shows that dividend payers tend to really shine in post-recession environments. Historically low yields on fixed-income products right now only make dividend payers even more attractive. Data compiled by Ivy Funds shows that in post-recessionary calendar years since 1968, high dividend payers have posted an average 11.5% annualized return, while low- or no-dividend payers only earned 7.2% in these same periods.
Beyond yield
Given the evidence, it's clear that owning dividend-paying stocks is a winning strategy, especially in economic recovery periods. Furthermore, so many companies' decisions to raise or reinstate their dividends bode well for the recovery down the road. That means investors currently sitting on the sidelines may end up missing out.
Of course, it's not enough to simply look for companies with the highest dividend yields; a stock that has fallen on hard times will have a higher yield as its share price declines. Investors in search of yield should also consider a measure of profitability, such as return on equity and valuation. Looking for large-cap names with healthy dividend yields, high return on equity, and a forward P/E ratio lower than 15 revealed the following bargains:
|
Company |
Dividend Yield |
Return on Equity |
Forward P/E |
|---|---|---|---|
|
Johnson & Johnson |
3.7% |
27.5% |
11.2 |
|
Coca-Cola |
3.4% |
31.1% |
13.8 |
|
Merck |
4.4% |
30.4% |
9.0 |
|
PepsiCo |
3% |
37.5% |
13.8 |
|
McDonald's |
3.2% |
34.8% |
14.3 |
|
Abbott Labs |
3.7% |
27.4% |
10.2 |
Source: Yahoo! Finance.
Investors looking for some of the best ideas in dividend-producers today would be well advised to consider any of the names above for their portfolio.
Ultimately, I think the rest of 2010 will be a challenging time for investors. As the effects of the stimulus wear off, and the economy is left to stand on its own, growth will probably be anemic. However, if we take a clue from aggregate dividend policies, corporate America may be in better shape than many think. Volatility will likely remain high in the near future, but investors should act now to reap the profits that dividend producers are likely to generate in the coming quarters.
