Lots of dividends but very little yield: An add and a drop for the Dividend Income portfolio

09/17/2010 8:30 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

It’s raining dividends. Or at least thoughts of dividends.

First time ever dividends from companies that have never offered dividends. On September 14, Cisco Systems (CSCO) CEO John Chambers said the company is considering a 1% to 2% dividend for the fiscal year that ends in July 2011

Restored dividends from companies that cut or eliminated their dividends in the financial crisis and Great Recession. At a September 14 analyst meeting JPMorgan Chase (JPM) CEO Jamie Dimon said that the company would restore its dividend, probably in the first quarter of 2011, at a payout ratio of 30% to 40% of normalized earnings. JPMorgan Chase cut its dividend to 20 cents a share from $1.52 a share in the financial crisis.

Higher dividends from companies with histories of paying dividends: Yum! Brands (YUM), and Paccar (PCAR) both announced on September 14 that they would raise their dividends by 19% and 33%, respectively.

Why? Three reasons. And you can probably figure out all three. No rocket science here.

First, companies cut dividends—big time—in the Great Recession. In 2008, the companies in the Standard & Poor's 500 Index cut their dividends by $42.6 billion, a record for any year. But that record stood only until the numbers were in for 2009, when companies in the &P 500 cut their dividends by $52.9 billion. Now that the future doesn’t look quite so dark, companies are either restoring their dividends or raising them again.

Second, companies are sitting on a tremendous amount of cash. Cisco Systems, for example, had $39.9 billion in cash at the end of the company’s July quarter. A 2% dividend comes to roughly $2.4 billion on the company’s 5.7 billion shares. That’s about 6% of the company’s current cash on hand and roughly equal to the company’s pre-tax operating income last quarter.

But neither of these first two reasons would be quite so compelling from a CEO’ point of view if not for the last reason.

Third, with interest rates so low—a 2-year Treasury yielded just 0.49% and a 5-year note just 1.42% on September 14--and investors so desperate for yield, a relatively modest dividend payout gets a lot of attention and has a big effect on a stock’s price. The day that Cisco Systems announced that was considering a 1% to 2% dividend, Cisco’s shares, which had been in decline from $24.77 on August 8 to $21.26 on September 13 popped 19 cents adding $1.3 billion to the company’s market value. Another 23-cent gain in the stock price and the dividend will have paid for itself.

The rain of dividends and the reasons behind it, though, aren’t an unmixed blessing. Think of it this way, if a company can get a big pop from a very modest increase in its dividend, why should it offer investors a big yield? So, for example, Paccar’s 33% dividend increase takes the quarterly payout to 12 cents from 9 cents. The yield on the stock went to 1% from 0.8%. Same with the increase in dividend at Yum! Brands. With the increase in dividend to 25 cents a quarter from 21 cents, the yield will go to 2.2% from 1.9%.

In other words, in this market you’ve got a whole lot more stocks paying dividends but most of those are paying relatively paltry yields. Another effect of the low yield environment is that companies with stocks that are for other reasons than dividends already on the march don’t feel compelled to raise their dividends to keep up with their stock price.

So the shares of a agricultural company such as Archer-Daniels-Midland (ADM), which paid a 2.4% yield back in early July—a yield almost a full percentage point above the yield on a 5-year Treasury note—now, after riding the agricultural commodities rally, pays just 1.8%. And that’s only 0.4 percentage points above the 5-year Treasury.

So while I’d say that the rain of dividends is a very nice benefit to folks who already own the shares in question, it isn’t exactly a solution to the problem facing most income investors in this financial market: How do I find a decent yield?

The situation wasn’t all that different the last time I revised my Dividend Income portfolio on May 28, 2010. As was true then, if you want to get a higher yield, you need to go for an unfamiliar vehicle such as a master limited partnership or an income trust where the tax issues aren’t favorable for every investor or to go for a common stock in a depressed sector.

So on May 28, 2010 I added an oil company, and a European oil company at that, Total (TOT) at a time when neither oil stocks nor European stocks were in favor. That’s worked out reasonably well. I’ve got an 8.8% gain on the stock’s price and if I hold (and I intend to) until the November 12 record date, I’ll collect a dividend of Euro 1.14 or about $1.48. That will be a dividend payout of 3.2% for six months.

On the same date I added shares of Banco Santander (STD), a European bank stock. This buy in an even more depressed sector has gained 27.8% since then and if I hold until the November record date, I will have collected a dividend payout of 2.7% for six months.

I’m not going to turn over very much of the Dividend Income portfolio today. Most of the stocks in the portfolio either represent depressed sectors and should show capital gains if we get even a half-speed recovery, or they represent a class of unfamiliar vehicles such as master limited partnerships, or they are scheduled to pay their dividend in the next month or two and I’m inclined to hold until I collect.

The one stock I am going to sell and replace, American Electric Power (AEP), held its value well during the recession but utilities will fall increasingly out of favor if we get my half-speed recovery. So I’m selling it out of the portfolio despite its 4.6% yield because I think a likely drop in stock price will negate that income. I’ve got a 4.03% appreciation in the stock’s price and a dividend payout of 3.6% since I added the stock to this portfolio about nine months ago on December 11, 2009.

I’m replacing American Electric Power with Intel (INTC). Because the technology sector, especially chip makers that do big business in the consumer PC market, has been so out of favor this summer, the stock pays a yield of 3.4%. That’s substantially above the yield on even a 10-year U.S. Treasury at 2.7%.

 Remember that one of the core goals of this portfolio is to beat the yield on a 10-year Treasury. The other is to control downside risk so that the total return exceeds that benchmark. With technology stocks among the leaders in the recent rally and with the market moving from the worst to the best quarters for technology stocks, I think Intel meets that test.

You can find  a list of all ten stocks in the portfolio and how they’ve done since I purchased them--by going to the Dividend Income portfolio page by following this link http://jubakpicks.com/ .

Full disclosure: I don’t own shares of any stock mentioned in this post in my personal portfolio.

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