As predicted. Aivars Lode
By Jeff Benjamin
April 15, 2012 6:01 am ET
With bond yields at historic lows, investors have turned to dividend-paying stocks as a source of investment income.
Now investors are getting an extra boost — call it an added dividend — in the form of rising prices of dividend-paying equities.
The long-term contribution of dividends to an investment's total return is well-documented.
But as dividend investing becomes increasingly popular, the resulting demand is driving up stock prices. This, in turn, could encourage even more companies to declare dividends.
The pressure to introduce and increase dividends could get intense, said Joshua Peters, an equity analyst at Morningstar Inc.
“Chief executives and corporate boards are going to start noticing that investors are rewarding dividend-paying stocks,” he said.
“Some companies might be dragged kicking and screaming [to start paying dividends], but investors are starting to pay attention, and they're starting to ask why some companies aren't paying dividends,” Mr. Peters said. “This is not a fad and it's not solely cyclical; I think we're in the early innings of a reversion to the mean of where we were in the 1950s and 1960s, when dividends were more common.”
It might just be a coincidence that in the midst of this renewed focus on dividends, Apple Inc. (APPL) announced plans to introduce a quarterly dividend of $2.65 a share. At a total of about $10 billion a year, it is the biggest dividend payout ever.
Investors have ex- pressed strong approval, driving the stock price up 7% from where it was the day before Apple's March 19 announcement through last Wednesday. By comparison, the S&P 500 fell 2.6% over the same period.
There is no denying the appetite for dividends among investors.
Last year, registered investment products that focused on paying dividends had $26.6 billion in net inflows, while the full universe of registered equity products experienced $178.2 billion in net outflows, according to EPFR Global, which tracks fund flows.
So far this year, dividend-focused products have had $15.4 billion in net inflows, while the universe of equity products had net inflows of $19.8 billion.
APPEAL OF COMPOUNDING
The initial appeal of dividends for most investors is often as straightforward as the basic math of compounding.
Lowell Miller, portfolio manager and founder of Miller Howard Investments Inc., makes the point by calculating the total return of $1 invested in the S&P 500 from 1936 through 2010.
The value of the initial investment, excluding dividends, would have grown to $93.65 over the 75-year period. But by reinvesting the dividends, the value would have spiked to $1,740.30.
“In our view, that's how investing should work,” Mr. Miller said. “You invest capital, and you get some return now and some in the future.”
To tap into the power of dividends in a growth play, investors should focus on companies that are initiating and/or increasing dividend payments — signs of strong balance sheets and potential capital appreciation.
Although George Fraise, principal at Sustainable Growth Advisers LP, takes the backdoor approach to dividend income by tracking a company's free cash flow, the end result is often the same.
For instance, the focus on free cash flow led Mr. Fraise to invest in Apple long before the dividend was announced.
“The best proxy for high dividend growth is free cash flow over time,” he said.
According to Mr. Fraise's analysis of the S&P 500 over the 10-year period through 2010, those companies with the highest dividend growth generated a combined total return of 177%.
LOOKING FOR GROWTH
This compares with a 56% combined total return for those companies in the index with the highest dividend yields but the lowest growth in dividend increases.
Looking beyond dividend yields and focusing on the direction of those dividends is where a lot of dividend strategies separate from the pack, and where investors should be looking for growth.
Don Taylor, manager of the $9.7 billion Franklin Rising Dividends Fund (FRDPX), places particular emphasis on companies with a history of “consistent and substantial dividend increases.”
“During the tech bubble of the late 1990s, dividends had fallen tremendously out of favor because paying a dividend used to mean a company couldn't grow,” he said. “But over the last several years, dividend stocks have done well in the marketplace, and now corporate management and boards are seeing that the markets are responding positively to more-enlightened dividend policies.”
Given the trends, investors should find a diverse collection of dividend-paying com-panies.
“There's something for everyone,” said Mr. Miller, who cited International Business Machines Corp. (IBM) and McDonald's Corp. (MCD) as among the best examples of companies that are increasing both dividends and stock price.
But if you are looking for turnaround stories, he recommends General Electric Co. (GE) and International Paper Co. (IP).
For market dominance, Mr. Miller likes The Boeing Co. (BA), Intel Corp. (INTC), and Taiwan Semiconductor Manufacturing Co. Ltd. (TSM).
Fast growth? Mr. Miller gives the nod to Unitedhealth Group Inc. (UNH).
“More stocks are moving in the direction of dividends than I've seen in a long time,” he said. “The idea that dividends are just for big, slow, blue chip companies has been promoted by people who take an aggressive approach to stocks, and it misses the compounding effects of dividends.”
Questions, observations, stock tips? E-mail Jeff Benjamin at email@example.com