Gary Shilling Blog

Stock Dividends 

Although most equity investors today concentrate on capital appreciation, dividends are an important part of stocks’ total return. They were much more so in earlier years, so the long-run average for dividends’ contribution overstates their current importance. Dividend yields today of 2% on the S&P 500 are distinctly below the 3% that was the floor in earlier years. Dividend payout ratios are rising in an era of uncertain stock appreciation when investors want more return here and now, but at 51% are still not high by historical standards. 

Furthermore, investor reactions to dividends today are mixed. Relatively high dividend yields is not tempting investors to buy energy and mining companies where earnings are plummeting and whose dividends earlier were considered rock solid. Since the beginning of 2015, the S&P index of metals/mining shares is down 49% while the energy index dropped 27%. 

Swiss-based miner and trader Glencore has embarked on a debt-reduction plan of more than $10 billion, including a suspension of its dividend and a $2.5 billion share offering. Anglo American, which lost $5.6 billion in 2015 after a net loss of $2.5 billion in 2014, has cut its dividend while taking massive write downs on many projects. The company plans to exit the coal-mining business and sharply curtail its iron ore operation while cutting its mining businesses to 16 from 45, a further reduction from the 25 target announced last December. In mid-February, Moody’s slashed Anglo American’s credit rating to junk. 

Copper mining giant Freeport-McMoRan dropped its dividend, cut capital spending and is selling 13% of its huge copper mine located on the Arizona-New Mexico border for $1 billion in order to pay down debt. Another major miner, Rio Tinto, cut its dividend in early February as the ongoing commodity price collapse pushed it to an annual loss in 2015. The company said it could no longer maintain, much less steadily increase, its dividend each year and plans to halve its 2016 dividend from 2015’s level. Similarly, last month BHP Billiton, the world’s top miner by market capitalization, abandoned its progressive dividend policy as it slashed its dividend by 75% amidst a $5.67 billion loss in the second half of 2015. 

Ceasing to increase dividends every year, much less cutting them, has been devastating for the miners and other commodity producers. At the same time, investors are flocking to predictable dividend payers, especially recently as it became less likely that the Fed will raise rates this year, and, I believe, is more likely to cut them instead. Note that after the Great Recession, the ECB and the central banks of Sweden, Israel, Canada, South Korea, Australia and Chile all raised rates but subsequently cut them. So the Fed would not be alone. 

This year, the stocks in the S&P High-Yield Dividend Aristocrats Index—companies that have increased their dividends every year for at least 20 years—are up 3% including dividends while the S&P 500 index suffered a total return drop of 2.8%. The total return on the S&P Utility index is up 6.7% year-to-date and I’ve favored utilities for years because of their attractive dividends as well as predictable earnings based on services consumers buy in good times and bad. 

Banks are not immune from dividend cuts, and big British bank Barclays just slashed its dividend by more than 50% as it reported a loss of $552.6 million in 2015 vs. $244 million the year before. 

Share Buybacks 

Many companies prefer share buybacks to dividend payouts because they don’t imply long-term commitments. Still, many announced buybacks are never completed, and the tendency is to buy high, sell low. Buybacks are often made at stock price peaks when CEO's are feeling confident and corporate cash is ample. In contrast, few are announced at equity price bottoms when fears of liquidity shortages if not bankruptcy are widespread.  

In any event—as with dividends—investors of late have not been impressed by buyback announcements even though they increase earnings per share by reducing shares outstanding. Furthermore, buybacks often simply offset stock awards to company employees. Since the financial crisis, firms have repurchased $1.3 trillion in shares. Over the last three years, reductions in equities outstanding have increased S&P earnings per share by 2%, as of the last quarter.

Buy ‘Aristocrat’ Funds for the Quality, Not the Dividend Yield

Funds centered around dividend royalty are about harnessing quality stocks, not headline income

That same dividend profile bleeds over into funds that focus on big baskets of these lauded dividend growers, resulting in modest yields for the most part. So it’d be natural to look at funds with names like the ProShares S&P 500 Aristocrats ETF (NOBL) or Vanguard Dividend Appreciation (VIG), see their sub-2% yields and think, “What’s the point?” 

The answer? “Not the dividends themselves.” 

You see, when a company is able to steadily increase its dividends for an extended period of time, that speaks to a certain measure of financial stability. And that’s where you get to the value provided by these funds. The focus on prolonged dividend growth isn’t about trying to put together a portfolio of eye-popping dividend yield — it’s about building a fund with high-quality holdings.

Vanguard Dividend Appreciation Index Fund Investor Shares (VDAIX)

This low-cost index fund seeks to track a benchmark that provides exposure to U.S. companies that have a history of increasing dividends. The fund focuses on high-quality companies that have both the ability and the commitment to grow their dividends over time. One of the fund’s risks is the possibility that returns from dividend-paying stocks will trail returns from the overall stock market during any given period. Another risk is the volatility that comes with the fund’s full exposure to the stock market. An investor with a well-balanced, long-term portfolio who seeks some income and exposure to dividend-focused companies may wish to consider this fund.

DYI Comments: When the market avails itself to increased valuations here is a fund that has potential for the possibilities of greater returns than the general market.  At least with its focus on dividends the volatility could be reduced as well.  Recommend that the fund be placed into a retirement type of account (IRA, Roth IRA, 401k if available) to shelter the income.  Something to keep in mind, DYI will.

DYI