9/27/2011 4:30 PM ET|
Sleepy stocks, eye-opening returns
The power of compounding dividend payments means go-nowhere stocks like ConEd, Procter & Gamble and PepsiCo can pay off big.
A lousy end to summer for world stocks has left fat dividend yields easier to find.
The MSCI All Country World Index lost 13% during the third quarter through Tuesday and carries a 3% dividend yield, according to Bank of America Merrill Lynch. Its eurozone component, which tumbled 22%, now pays 5.5%.
Even in the U.S., where yields are much stingier, one-quarter of Standard & Poor's 500 Index ($INX) members now pay more than 3%.
For long-term investors, that might be reason enough to put spare cash to work. Gains are grand, but even sleepy stocks can pay off nicely given the combination of dividends, reinvestment and time.
Consider New York City's power company, Consolidated Edison (ED). It's old economy, to say the least: One of its predecessor companies, New York Gas Light, was listed on the New York Stock Exchange 23 years before Thomas Edison was born.
Today, ConEd has single-digit sales growth and its shares are one-fifth as volatile as the broad U.S. market. (Yawn.) Over the past decade, its stock price has only slightly outpaced inflation. But with reinvested dividends, shares have returned 128%. The S&P 500 index returned 33% over the same period with dividends reinvested.
And plenty of big dividend payers have paid off bigger than ConEd over the past decade, assuming reinvestment. Oil producer Chevron (CVX) has returned nearly 200%, while Altria Group (MO), the U.S. tobacco giant (before 2003 it was called Philip Morris), has returned more than 300%.
These returns don't subtract for taxes. But dividend taxes are capped at 15% at least through 2012, and taxes are deferred altogether in qualified retirement accounts.
Slow growth can pay
What do the aforementioned companies have in common, besides their dividends? They're slow growers. That sounds like a negative, but slow growth can bring two benefits. First, a limited need to spend on expansion allows such companies to boost dividends as profits rise. ConEd, for example, has increased its dividend for 37 straight years.
Second, a lack of attention from growth-obsessed investors tends to keep stocks like these from reaching bubbly levels. That means investors generally can reinvest their dividends at fair prices.
Together, those traits can create ideal conditions for what Einstein famously called the most powerful force in the universe: compound interest. (We'll assume he meant compounded dividends, too.)
Boring is back, for good reason
To investors clinging to memories of a booming stock market, dividend-collecting might sound boring. But there are two good reasons to believe that boring will outperform in coming years.
First, stock returns don't typically consist of exciting price gains with dinky dividends tacked on. Over eight decades ended September 2010, dividends contributed 44% of S&P 500 total returns, according to research by Fidelity Investments. And that includes a long, anomalous stretch during the 1980s and 1990s, when valuations bloated and yields shrank. During the 1970s, when returns averaged just 5.9% a year, dividends contributed 71%.
Second, from here, broad-market returns might be smaller than investors are accustomed to. Bradford Cornell, a finance professor at the California Institute of Technology who specializes in valuation, argued in a paper published last year in Financial Analysts Journal that stock returns are inextricably tied to economic growth, which is necessarily slowing around the developed world. Stock investors, he says, should expect to collect their dividend yields plus about 1% a year in price gains after inflation.
The good news is that more S&P 500 companies have raised or initiated dividends this year through August than during the same period during at least the past seven years. They have plenty of room for more increases; payments are less than one-third of profits, a historic low.
Finding the plays
To find companies that might be capable of delivering dividends for another decade or two, a good starting point is the Dividend Aristocrats list maintained by Standard & Poor's. These are S&P 500 members that have increased their payments for at least 25 years running. There are 42 in total, and 15 of them pay at least 3%. In addition to ConEd these include Johnson & Johnson (JNJ), Emerson Electric (EMR), PepsiCo (PEP), Abbott Laboratories (ABT) and Procter & Gamble (PG).
For exchange-traded fund investors, the PowerShares Dividend Achievers (PFM) consists of companies that have raised their payments for at least 10 consecutive years. Wal-Mart Stores (WMT) is its biggest holding. The fund yields 2.6% and has annual expenses of $60 per $10,000 invested. The Vanguard High Dividend Yield (VYM) ETF is focused on yield (not payment growth), but it holds plenty of chronic dividend boosters just the same. Biggest holding: Exxon Mobil (XOM), which has increased payments by an average of 5.7% a year for 27 years, making it a Dividend Aristocrat. The fund yields 3.3% and costs a slim $18 a year per $10,000 invested.
Yields like these, if reinvested, might help portfolios expand in coming years even if share prices don't.
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