“In the short run the market is a voting machine, but in the long run it is a weighing machine.” Benjamin Graham
Readers who’ve come across my old articles know I’m a diehard dividend-growth fan. Have been for over a decade. Will be until I find an easier way to make money, which I doubt will be anytime soon.
And that brings us to lately. Lately, dividend-growth stocks are a snooze. Not because their dividends stopped growing. Nope. With high corporate profits and cash levels, but low interest rates and payout ratios, dividend boosts keep getting bigger and better. Despite that happy circumstance, dividend growers have been stuck in the slow lane, lagging the market by a mile recently.
Don’t get me wrong, like many dividend-growth investors I can ride out fluctuating stock prices because my dividends rise even when prices don't. But I still enjoy seeing my stocks go up. It’s more fun that way. (More money, too.)
And believe it or not, over the long run dividend-growth stocks go up a lot more than the market. We’ll get back to that in a minute … but first, what’s going on now?
Let’s start by comparing the S&P 500’s stellar 16.3% five-month total return for Q4 2010 through February 2011 to returns for a couple of ETFs that track dividend-growth indexes. The S&P High Yield Dividend Aristocrats ETF (SDY), comprising stocks with at least 25 years of dividend increases, captured slightly over half the market’s return, a relatively lethargic 8.6% including dividends. The Powershares ETF (PFM) that tracks the Dividend Achievers Index, stocks with at least 10 years of dividend hikes, fared better but still lagged the market at 12.0%.
But dividend stocks always fall behind in bull market moves, right? Not exactly. In the bull blastoff from March 2009 through Q3 2010, SDY clobbered the index with a 75% total return vs. 55% for the S&P 500. PFM stayed close at 51%. Since then, sleepy time.
Of course, individual stock portfolios can be far different from these ETFs. SDY and PFM simply give us a glimpse of the dividend-growth universe. So let’s check out a diversified 12-stock portfolio of classic dividend-growth hall-of-famers:
1. Abbott Labs (ABT)
2. ADP (ADP)
3. Chubb (CB)
4. Coca-Cola (KO)
5. Emerson Electric (EMR)
6. Exxon Mobil (XOM)
7. Illinois Tool Works (ITW)
8. Johnson & Johnson (JNJ)
9. McDonald's (MCD)
10. Pepsi (PEP)
11. Procter & Gamble (PG)
12. Realty Income (O)
Sure, there’s room for debate on these, but I’ll bet most dividend portfolios include many of them. (Mine sure does.)
How’d they do? Compared to the S&P 500 total return of over 16% for Q4 2010 through February 2011, this particular dreamy dozen was a bit drowsy at 9.8%. Include high-yield favorites Altria (MO), AT&T (T), or some of the popular dividend-growth utilities, and returns get even worse. Ditto if you swap out XOM for Chevron (CVX) or Conoco-Phillips (COP), or switch techie ADP for Intel (INTC). No doubt about it, high-quality dividend-growth stocks seem a little sleepy right now.
And that’s strange because most of the time dividend-growth stocks aretireless moneymakers. Here’s a quick look at the long-run weighing machine:
- A Ned Davis Research study, from 1972 through early 2010, shows stocks of companies with at least five years of dividend growth, and those initiating dividends, popped total returns averaging over 9% yearly. Those maintaining steady dividends averaged over 7%.
- During the same period, non-dividend payers pulled in less than 2% a year. How pathetic is that? Less than 2% a year for more than 37 years.
In another long-term study, using a different group of stocks, time period and return metric, AllianceBernstein researched the largest 1500 stocks by market capitalization from 1964 to 1999.
Over those 35 years, AB found that in the year following a dividend increase, dividend raisers’ total returns averaged a healthy 1.8 percentage points more than stocks that did not raise dividends.
Meanwhile, the Dividend Achievers Index outperformed the S&P 500 for the 1-year, 3-years and 10-years ending October 2010; while the Dividend Aristocrats Index beat the S&P 500 over just about any long-run time frame you can name, including absolutely royal total returns of 6.5% annually during the lowly “lost decade” of 2000 through 2009.
So it’s hard not to like stocks like these for your long-run money. But the long run doesn’t include every quick sprint, and now is hardly the first time these stocks coasted a couple of laps.
For example, dividend stocks underperformed the market in the late 1990s, when tech titans and internet eyeballs scored higher valuations than cash dividends. And they lagged again in 2003 when the market re-launched on renewed economic and profit growth.
So why are dividend-growth stocks dozing now, and what might investors do?
First, I think it’s instructive that these stocks began lagging in the late 2010 market lift-off that accompanied fresh hopes for economic expansion. Shades of 2003. Among the new lift-off leaders: basic materials, led by dividend cutters Alcoa (AA), Dow (DOW) and Freeport-McMoRan (FCX); formerly busted big banks already booted from dividend-grower lists; and energy services stocks, including oil spill bad boy Halliburton (HAL), for example.
Hmm. Not many of those in most dividend-growth portfolios. More typical dividend portfolio weightings, in defensive sectors like healthcare, consumer staples and utilities, have taken hits on rising forecasts for macro growth, stimulative interest rates, and some high profile patent worries, product recalls and input inflation. Some of these headwinds seem transitory; others are perhaps just getting underway.
Yet none of this suggests any fundamental changes in the reasons to own dividend-growth stocks for the long haul. Beyond their stellar total return history, these stocks offer investors ownership in world-class businesses, a rising yield-on-cost on the initial investment, growing income to offset inflation, and reliable cash flow that doesn’t require selling depressed shares during bear markets. What’s not to like?
Bottom line: dividend fans holding newly snoozy portfolios might try what I’ve decided to do: track my portfolio against dividend indexes to see that I’m still in the ballpark, make sure my stock fundamentals stay strong, watch my sector allocations, delight in my growing dividends, and simply wait. It’s easy to be patient with a pocket full of dividend cash and decades of research to read about.
Originally published by Morningstar, March 14, 2011
Disclosure: I am long ABT, CB, COP, CVX, JNJ, KO, O, PG. Also long a number of other dividend growth stocks
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