Value in Dividend Plays
Europe may slowly implode. That could cause problems for the financial
sector, and the broader global economy. Even in the face of such developments,
there are many blue-chip, dividend-paying stocks that are likely to provide
excellent value over the long term, while providing a very high relative yield
in the short term.
The dividend yield on the S&P 500 exceeds the yield on the 10-year Treasury
note. This is extremely rare.
Until recently, it had been over 50 years since the dividend yield on the S&P
500 exceeded the 10-year Treasury note. It happened in December 2008, when
the dividend yield went to 3.3% and the Treasury yield dropped to 2.7%.
At that time, there were legitimate concerns that financial companies would
cut dividends -- which they soon did. That partly explained the high
relative yield from dividends. Nevertheless, the stock market is up 35.1%
from December 2008 when this highly unusual relationship appeared.
The Situation Today
The current yield on the S&P 500 is 2.1%. That is above the current yield on
the 10-year note of 1.9%.
This represents great value.
In fact, there are so many solid blue-chip companies paying dividends so far
in excess of the yield available on government securities (or even corporate
bonds) that it is hard to understand the rationale for bonds over selected
For example, Johnson & Johnson (shares of which your author owns)
sports a dividend yield of 3.58%.
This is a company that still holds a AAA rating. It increased profits
in 2009, 2010, and each quarter so far in 2011, despite the recession in 2008
and subsequent weak U.S. growth.
The company has raised its dividend by a total of 24% over the past three
years. The dividend increase last year was 5.6%. Its current
dividend payout is 45% of profits. There is room for continued dividend
increases in line with likely earnings growth, which is estimated at 5% to 7%
for the next several years.
If the company raises the dividend by 5% per year the next five years, that
means the dividend yield on a current investment will rise to 4.6% (future
dividend divided by current stock price).
The company also happens to generate approximately three-quarters of its
revenue from overseas, where a great deal of its growth is generated. The
slow growth in the U.S. does not preclude solid revenue growth.
Given the company's strong balance sheet, steady profit and dividend growth,
and overseas growth, the recent volatility in the stock is hard to explain
Should this stock really swing $1 or more on a daily basis based on the
problems German banks face because of a possible Greek default? Should the
stock price drop sharply because of the risk of weakening global economic
Our answer is a strong "no." For the dividend alone, this stock has
value, and anyone willing to ride out the swings in the stock price will
continue to collect the 3.6% dividend, and almost certainly see dividend
increases in the years ahead. After all, the company has raised the
dividend 49 straight years and it isn't about to stop now.
This is an investment which, in our opinion, is highly likely to outperform
Treasury bonds over the next several years. An investor who buys a 5-year
note yielding just 0.8% and holds it until maturity will lock in that meager
0.8% annual return for five years.
Meanwhile, rising profits and dividends, despite Greece and Europe, are
likely to support Johnson & Johnson stock over the same five-year period. And
during that time, the 3.6% dividend yield will rise, and compound.
Johnson and Johnson is by no means the only stock with this type of profile.
There are numerous high-quality stocks yielding 2% or more that have a long
history of raising dividends. Holding these stocks and cashing the
dividend checks may well prove a sound long-term investment given current
alternatives. Granted, if the stock market takes off at some point in the
next few years, these stocks will probably underperform the overall market.
We eagerly await that development.
Below is a list of blue-chip stocks with current yields listed along with the
number of consecutive years the company has raised its dividend. These
companies have strong balance sheets, relatively stable earnings trends, and are
supported by international growth. (The list is presented for informational
purposes and is not a list of recommendations.)
& Gamble (PG)
The high quality stocks noted above are not the only possible dividend plays.
There are numerous stocks paying 2.5% dividend yields or higher. This is
evidenced by the fact that the 500 stocks in the S&P 500 provide a weighted
average return of 2.1%, even while many companies still pay no dividend.
Johnson and Johnson and the stocks listed above are also not the only stocks
likely to raise dividends in the immediate years ahead.
Despite the incessant concerns about European problems and persistently weak
U.S. growth, revenue growth for the S&P 500 has actually been strong recently.
Revenue was up 12% in the second quarter on a year-over-year basis.
Profits were up 12% (18% excluding Bank of America). The resulting stronger
balance sheets have led to rising dividends
Dividends on the S&P 500 stocks increased 1.4% in 2010, according to Standard
& Poor's, and are indicated to be up 17% in 2011.
Despite these increases, the payout ratio remains low. In fact, as a
percentage of profits, corporations are now paying out just 28% in dividends,
according to data from Robert Shiller. This is the lowest payout ratio on
record in data from Mr. Shiller that dates back to 1871.
There is a lot of potential for dividend increases from companies not
directly exposed to European financial problems.
What It All Means
This is an excellent time to invest in high-yield dividend stocks. It may
take an iron stomach to sit through the volatility, but just as in December
2008, a long-term strategy is likely to pay off.
Selected dividend yields are particularly enticing given the extremely low
rates on Treasury bonds. The Fed has indicated that rates will remain low for an
extended period of time -- possibly years and years. That means that
current dividend yields from financially secure stocks are likely to outperform
the interest rate returns from bonds.
Furthermore, dividend payout ratios overall are low. Dividends have
been increasing in recent years and there is room for further growth even in a
low earnings growth environment. Many companies raised dividends every
year through the recent recession, and are likely to do so the next several
years regardless of what happens in Greece.
High quality companies with a strong track record of raising dividends are a
relatively appealing option for many investors with an intermediate to long-term