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3 reasons why the golden age of dividends is dawning

Last updated on: May 27, 2013 15:14 IST

3 reasons why the golden age of dividends is dawning

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John Wasik

Most profitable corporations are hoarding cash that could be channeled into dividends.


The golden days of summer might also brighten the portfolios of dividend lovers.

With most large corporations swimming in cash as the economy and earnings improve, adopting a dividend-centric strategy looks even more promising for moderate-risk investors.

Dividends, the portion of earnings that corporations pass along to shareholders in the form of quarterly payments, are becoming more generous. Not only do they reward long-term shareholders with higher total return, they are proven inflation hedges.

At the end of last year, the number of companies paying a dividend hit a new, 13-year high, FactSet reports. And while dividend payout ratios are close to their median level, they are at their highest level since the recession hit in 2007.

The current yield of S&P 500 stocks is around 2 per cent, which beats most insured savings accounts. Unless a slowdown triggers earnings declines, the dividend surge is expected to continue.

That's because the most profitable corporations are hoarding cash that could be channeled into dividends. Last year, companies increased their reserves to $1.45 trillion, according to Moody's Investor Services, up from $1.3 trillion in 2011.

While profits can also be used to buy back shares or be invested in research and development - as many companies are doing - they are increasingly redirected into dividend payments.

Here are three reasons why dividend-seekers will be rewarded.

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Image: Traders work on the floor of the New York Stock Exchange.
Photographs: Brendan McDermid/Reuters

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Hoarding cash

Companies hoarding piles of cash may not have the biggest incentives to pay dividends, but they are facing intense pressure to raise their payouts as shareholders get active. Apple, sitting on nearly $138 billion in cash at the end of last year, bowed to shareholder demands to share its pile of money.

All told, Moody's estimates, technology companies have more than a half-trillion dollars in cash on hand. "The sector with the most cash and reasonably low yields and payouts is technology," said Bob Doll, chief equity strategist for Nuveen Investments. "I would expect the biggest increases there."

There's a broad selection of tech high-yielders, including Intel at 3.7 per cent.

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Photographs: Reuters

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Payout ratios climbing

Investors are seeing a cyclical increase in the amount of earnings that flow back into dividends. That payout ratio is important to watch because it shows the percentage of profits turned into dividend payments.

Higher ratios are usually better for shareholders. The average payout ratio for the S&P 500 companies ranged between 40 per cent to 50 per cent from 1981 through 2000, according to research from Scottrade, the discount brokerage.

After the dot-com bust and again immediately following the 2008 crash, though, companies got more conservative with their cash management. At the end of 2011, the payout ratio was at 28 per cent. By the close of 2012, it rose to 30 percent.

Analysts like Doll expect ratios will "drift into the 40s over the next couple of years as dividend increases exceed earnings increases." Ultimately, the companies with the best cash flow and earnings reports will lead the pack.

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Photographs: Reuters
Tags: Doll , S&P , Scottrade

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Cash consistency counts

The conventional wisdom has always been that companies choosing to re-invest their cash in their businesses have greater growth prospects - that's not always the case. The two recessions and stock-market downturns during the past dozen years have made companies much more efficient. Relying more on technology, they have downsized their workforces. Although that is a sour story for employment, it's freed up more cash.

Some top dividend yielders include Pitney Bowes, which pays a 5 per cent dividend; Altria Group, at 4.8 per#162 and Entergy at 4.9 percent.

Companies building up their businesses while boosting cash flow increasingly reward shareholders with higher dividends. The telecommunications sector, for example, fed by the steady growth in mobile devices, pays the highest dividends among S&P 500 companies, according to FactSet Dividend Quarterly.

Telecom companies pay an average 4.4 per cent yield, compared to 2 per cent for the S&P 500. Along with tech companies, they are in the best position to grow their dividends. Verizon , yielding nearly 4 per cent and AT&T, at almost 5 per cent, are good examples.

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Photographs: Reuters

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Best dividend strategies

You don't have to buy single stocks to grab decent yielders. Exchange-traded and mutual funds offer diversified portfolios of the best performers.

My best candidate is the Vanguard Dividend Growth fund which owns 147 dividend "achievers" that are expected to raise their dividends. It is up 26 per cent for the year through May 22 and 16 per cent year to date.

Another worthy alternative is the SPDR S&P Dividend ETF which is up 32 per cent for the year and 20 per cent year to date.


Photographs: Reuters

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