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At a time when investors are clamoring for income, U.S. corporations remain too stingy with dividends.
The benchmark Standard & Poor's 500 index has a dividend yield of just 2%, one of the lowest of any major global market. European stocks yield an average of nearly 5%, and even the historically low-yielding Japanese stock market pays 2.5%.
American companies have the wherewithal to raise dividends because profits are at record levels and the payout ratio—the percentage of profits paid out in dividends—is near an all-time low at 28%. It has averaged 40% over the past 20 years.
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Most companies can afford to pay at least a 2% dividend, and many big companies are capable of paying close to 4%. Among them are ExxonMobil (ticker: XOM), Microsoft (MSFT), Apple (AAPL), Wal-Mart Stores (WMT) and Google (GOOG). In the banking sector, regulatory constraints are keeping a lid on dividends, but a capital-rich JPMorgan Chase (JPM) could get the go-ahead to lift its dividend to almost 4% this year.
A 4% dividend seems to resonate with investors who are willing to pay premium prices for companies with high yields. Some of the strongest S&P 500 industry groups last year—utilities, consumer staples and drugs—had some of the index's highest yields.
During 2011, high-dividend payers were the top-performing group in the S&P 500, with the top 50 yielders at the start of 2011—all with 4%-plus yields—returning more than 8% (not including dividends), compared with a flat showing for the entire index, according to Birinyi Associates.
"This is a market environment where dividend-paying stocks in and outside the technology sector have outperformed," says Toni Sacconaghi, technology analyst at Sanford Bernstein. "Investors increasingly value dividends in their assessment of stocks." He says that Apple, which pays no dividend, could pay 4% and still add considerably to its market-leading cash hoard of $81 billion.
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The tables nearby list 10 stocks with low or no dividends that could initiate or lift their payouts, including Exxon, Google, Apple and Berkshire Hathaway (BRKA), and 10 with yields of 4% or more. The companies on the second list, including Merck (MRK), Pfizer (PFE), Waste Management (WM) and American Electric Power (AEP), have sustainable dividends and reasonable price/earnings ratios.
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The biggest potential for dividend increases lies in the tech sector, which has the lowest yield of any industry group in the S&P 500 at 1.1%. Many companies, including cash-rich Google, eBay (EBAY), Dell (DELL) and Amazon.com (AMZN), pay no dividends, while others, like Oracle (ORCL) and Cisco Systems (CSCO), yield just 1%. Other industries with the potential for higher dividends are media, managed care, asset management and biotechnology.
This could be the year Apple starts offering a dividend, because CEO Tim Cook seems willing to consider it, telling investors last year: "I'm not religious about holding cash." Perhaps reflecting the company's early struggles, co-founder Steve Jobs never liked parting with cash. But Apple's cash is growing so rapidlyit could hit $100 billion at the end of the current quarter and $150 billion sometime next year without any action.
EVERY CEO WANTS a higher stock price, and dividends may be a better route than buybacks. "It's almost like dividend-paying stocks are their own asset class and trade at higher multiples than non-dividend-paying stocks," says Tavis McCourt, a technology analyst at Morgan Keegan. He has urged tech companies to boost their dividends.
Companies with high and sustainable dividends are often valued more like bonds than stocks, partly because 4% and 5% dividend yields often are higher than the rates on many corporate bonds.
"The marginal buyer of telecom stocks has been a fixed-income buyer," says Craig Moffett, a Bernstein cable-TV and telecom analyst. "The stocks are priced to a yield with almost no attention to traditional valuation measures like P/E ratios." Moffett notes that Verizon Communications (VZ), at $39, has benefited greatly from its 5% yield and trades at 15 times estimated 2012 profits, an unusually large premium to the S&P 500, which fetches a 12 P/E. Verizon's payout ratio is high at 80%.
Formerly stodgy utility stocks like Southern Co. (SO) now are popular with investors thanks to 4%-plus yields. Southern is up 20% in the past year to $46, and trades for 17 times projected 2012 profits. It has a P/E ratio that exceeds nearly all major tech stocks despite annual earnings growth of just 3%.
While some wonder if dividend investing is a fad, the strategy probably has staying power. Bonds yield little, and short-term rates are near zero, leaving individuals with few places to find yield. Demographics favor income investing; millions of baby boomers retire each year, and they want income to supplement Social Security and minimize the drawdown of retirement assets.
Opportunities are limited in the bond market, with Treasuries topping out at 3% and high-quality 30-year municipals at only 3.5% after a sharp rally in recent months. These yields are near the lows of the past 50 years.
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Investors are pouring cash into income-oriented equity-mutual funds while money has come out of most U.S. stock funds. Equity-income funds took in $31 billion last year, while U.S. equity funds overall lost $79 billion in 2011, Morningstar data show. Dividend-oriented exchange-traded funds like Vanguard Dividend Appreciation (VIG), iShares Dow Jones Select Dividend Index (DVY) and SPDR S&P Dividend (SDY) grew sharply in assets last year.
Value and income-oriented institutional investors own little Apple stock, despite its reasonable forward P/E of 11. Sacconaghi says that investors wonder why Apple's P/E ratio is low, given its high growth rate, and he thinks a key reason is that the company's refusal to pay a dividend limits its investor base. "Apple could attract significant classes of incremental investors by paying a dividend," he maintains.
MANY EXECUTIVES are understandably cautious about paying big dividends after the searing experience of 2008 and 2009, when a quarter of the companies in the S&P 500 were forced to cut payouts. Yet managements may be making a mistake now in favoring share buybacks. Even with the problem posed by the repatriation of foreign income, companies generally have plenty of U.S. profits to pay nice dividends.
Within the S&P 500, companies are spending more than $2 on buybacks for every dollar in dividends, according to S&P data. That split ought to change. Companies should consider returning as least as much in dividends as buybacks. The S&P 500 is valued at about 12 times projected 2012 profits. If companies adopted an average 40% payout ratio, the index's yield would be 3.3%, versus 2% now.
Investors have welcomed corporate moves to lift dividends to about 4% or more. General Electric (GE), Intel (INTC) and magazine publisher Meredith (MDP) all have seen their stocks benefit from marked dividend increases. Meredith is up 27% since it boosted its dividend 50% in October.
There's truth to the old line that buybacks favor sellers of a stock, while dividends benefit holders. Many institutions favor buybacks because they believe repurchases will push up stock prices and performance and make portfolio managers look good.
Yet companies often buy stock when times are flush—and their stock prices are high—and then regret those actions in downturns. Sears Holdings (SHLD), Eastman Kodak, New York Times (NYT), Cisco and Goldman Sachs (GS) all overpaid for their shares. Warren Buffett has said companies should buy back shares only when they trade at a marked discount to intrinsic value.
A dividend imposes discipline on managements that could otherwise spend heavily on acquisitions or buybacks. While institutions often urge big buybacks on conference calls, individual investors are voting for dividends.
"Technology companies view dividends as a sign of weakness and limited growth opportunities, but the very best businesses don't need much capital to grow," says Ken Broad, portfolio manager of the Delaware Smid Cap Growth Fund. "Apple is an exemplar of that." Companies like Coca-Cola (KO), Procter & Gamble (PG), Johnson & Johnson (JNJ) and Merck historically have been able to generate steady annual profit growth while paying out half their profits in dividends.
It's notable that a dividend leader in tech, Intel, also is one of the most capital-intensive. If Intel can pay a 3.2% dividend, others should be able to follow. Seagate Technology (STX), the disk-drive maker, also is capital-intensive, and it surprised Wall Street by instituting a 5% dividend last year. Says CEO Steve Luczo: "We have had significant positive support from our investor base, as well as a shift to more longer-term holders as a result of our dividend policy." McCourt says that cash-rich companies like Cisco made a mistake in setting low initial dividends. He says dividends must be at least 2% to matter to investors.
Google, like Apple, has a huge amount of net cash, some $40 billion, and has shown no desire to share it with holders. That may be hurting its stock price, which is down in the past year, despite robust profit growth, amid investor concern about capital discipline after such moves as its coming $12.5 billion purchase of Motorola Mobility, the cellphone maker, and its $2 billion buy of a Manhattan office building.
Big media companies such as Time Warner, (TWX), CBS (CBS), Disney (DIS) and Viacom (VIAB) should be paying higher dividends, according to Anthony DiClemente, a Barclays Capital analyst. "Media managers are afraid of the signaling effect, and they're slow to concede that their companies aren't the high-growth companies they used to be," he says. DiClemente says they can afford higher payouts, because they generate a lot of free cash flow, and their businesses are less exposed to volatile advertising, as they get more revenue from subscription fees for their cable networks.
Disney recently lifted its dividend by 50%, but it still yields only 1.5%. CBS yields 1.4%; Viacom, 2.1%, Discovery Communications (DISCA), nothing, and Time Warner 2.5%. "There is definitely an appetite for dividends in the investment community, and we don't have it in the media space," he says, save Time Warner. Some companies, particularly Viacom, emphasize stock buybacks.
DiClemente thinks dividends should be higher across the board,with CBS and Time Warner lifting theirs to 4%, and Disney and News Corp. (NWSA) going above 2%. News Corp., publisher of Barron's, has one of the group's lowest yields: 1%. Time Warner Cable (TWC) pays 2.8% and Cablevision (CVC), 4%. Look for cable giant Comcast (CMCSA) to boost its dividend next month, perhaps by 20%. It now yields just 1.7%.
Biotech giant Amgen (AMGN) more resembles Pfizer than a startup, yet its 2% yield is half that of major drug companies. ExxonMobil pays 2.2%, the lowest among major energy stocks. It has long favored buybacks, but should consider a more balanced approach. Royal Dutch Shell (RDSA) is the polar opposite, with a 4.8% payout and no buybacks.
Even Berkshire Hathaway should weigh a dividend, given its ample earnings. CEO Warren Buffett has been cool to the idea, because he'd prefer to invest Berkshire's earnings and has a phenomenal record doing so.
Yet Berkshire probably will pay a dividend—a sizable one—in the post-Buffett era when the Gates Foundation, the recipient of most of Buffett's holdings, will want income to meet annual spending requirements for charitable institutions. Starting small, with a dividend of 2%, could broaden the investor base and drive up the shares, which have been laggards in recent years.
E-mail: editors@barrons.com
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