Why There's Such a Dividend Deluge

09/17/2010 9:47 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

Companies are handing out dividends left and right, but the yields are hardly worth cheering about. What does an investor have to do to make money?

It's raining dividends. Or, at least, thoughts of dividends. We're seeing:

  • Dividends from companies that never have offered dividends before. On September 14, Cisco Systems (Nasdaq: 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 had reduced or eliminated their dividends during the financial crisis and the Great Recession. At a September 14 analysts meeting, JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon said his 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 had cut its dividend to 20 cents a share from $1.52 a share during the financial crisis.

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

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

A Little Goes a Long Way

First, companies cut dividends—big time—during 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 first quarter of 2009, when companies in the S&P 500 cut their dividends by $52.9 billion.

Now that the future doesn't look quite so dark, many companies are restoring their dividends or raising them.

Second, companies are sitting on a tremendous amount of cash. Cisco Systems, for example, had $39.9 billion in cash at the end of July. 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 pretax operating income last quarter.

But neither of these first two reasons would be quite so compelling from a CEO's point of view if not for the third reason:

With interest rates so low—on September 14, a two-year Treasury note yielded just 0.5% and a five-year note just 1.43%—and investors so desperate for better returns, a relatively modest dividend payout gets a lot of attention and has a big effect on a stock's price. The day that Cisco announced that it was considering a 1% to 2% dividend, Cisco's shares, which had declined from $24.77 on August 8 to $21.26 on September 13, popped up 19 cents. That added $1.3 billion to the company's market value. An additional 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 unmixed blessings. 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 per share. The yield on the stock went to 1% from 0.8%. Same with the increase in dividend at Yum Brands. With the increase in quarterly dividend to 25 cents 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 already on the march for reasons other than dividends don't feel compelled to raise dividends to keep up with their stock prices.

So the shares of an agricultural company such as Archer Daniels Midland (NYSE: ADM), which paid a 2.4% yield in early July—a yield almost a full percentage point above the yield on a five-year Treasury note—now, after riding the agricultural commodity rally, pays just 1.9%. And that's less than half a percentage point above the five-year Treasury.

NEXT: So Where Do We Find Decent Yields?


Quest for Yield Goes on

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 May 28, the last time I revised my Dividend Income Portfolio. 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, I added an oil company—and a European one at that, Total (NYSE: 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 1.14 euro, or about $1.48 per share. That would be a dividend payout of 3.2% for six months.

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

I'm not going to change much in the Dividend Income Portfolio today. Most of the stocks in the portfolio 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 dividends in the next month or two, and I'm inclined to hold until I collect.

One Addition, One Subtraction

The one stock I am going to sell and replace, American Electric Power (NYSE: AEP), held its value well during the recession, but utilities will fall increasingly out of favor if we get that 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 gotten a 4.03% appreciation in the stock's price and a dividend payout of 3.6% since I added the stock to this portfolio on December 11, 2009.

I'm replacing American Electric Power with Intel (Nasdaq: INTC). Because the technology sector, especially chipmakers that do big business in the consumer PC market, has been so out of favor this summer, the drop in stock price has raised the dividend yield to 3.5%. That's substantially above the yield on even a ten-year US Treasury (2.7%).

One of the core goals of this portfolio is to beat the yield on a ten-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 the test.

You can find the most recent performance numbers for this portfolio since I re-launched it in 2009—as well as a list of all ten stocks in the portfolio and how they've done since I purchased them—by going to my Dividend Income Portfolio page.

At the time of publication, Jim Jubak did not own shares of any company mentioned in this column in his personal portfolio.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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