Dividends Worth Chasing

03/02/2012 11:15 am EST

Focus: INCOME

Margaret Patel

Managing Director and Senior Portfolio Manager, Wells Fargo Advantage Funds

The rich payouts of income stocks suggest that equities remain a better bet than bonds, says Margaret Patel, managing director and senior portfolio manager at Wells Fargo Advantage Funds.

Margie, the dividend trade became rather crowded, rather popular in 2011. Where do you see that heading this year?

I don’t think it’s going to do as well this year, simply because it is so popular, and prices of these stocks have been bid up very, very high compared to the growth potential. I personally think growthier stocks with lower dividends might be a better performer this year.

Although certainly for an income-hungry investor, dividends have done the job, and in fact it’s interesting that for many investment-grade companies, say take a Procter & Gamble (PG) or a McDonald’s (MCD) for example, they have issued ten-year corporate bonds with a yield of around 2.3%—that’s a little bit better than the treasury yield of 2%.

But for raw yield, both of those companies offer a dividend yield—Procter has a yield of 3.3%, McDonald’s has a yield of around 2.8%—so incredibly enough, you can make more income if you simply buy the stock. So I think you have to be selective, but clearly for the income-oriented investor, it’s another thing that suggests that equities are a better investment value over the long term than fixed income at this point.

So for people who are concerned about income, for example in a retirement portfolio, are blue chips the way to go?

Yes, I think that’s always a good idea. They offer these dividend yields that are competitive with, and as I said in many cases, yield more than the bonds of the same companies. So for an income alternative, I think there’s a better buy in equities.

It’s true you may have price volatility, but for a long-term investor, you should be more looking at can the company grow the value of its shares? Can they maintain the dividend? I think in most of those cases, the answer is yes. So whatever prosperity we have, equities would be a better way for the investor to participate.

Now, we’ve been talking about interest rates, and obviously along those lines, the Fed is something that’s very top of mind for a lot of investors these days. Any Fed actions that we might want to be looking out for, be aware of in particular?

Yes, Chairman Bernanke has told us that he intends to keep rates low to the end of 2014, and I believe we will see that. And if there’s any sign that the economy is slowing down, I think we will see whatever actions the Fed can take to provide liquidity, keep those rates low. So I think the most important thing for investors is to realize that risk-free rates will stay low for a variety of reasons.

Actually, there is somewhat of a scarcity of Treasury securities—that seems incredible with the deficit that we have, but the reason is because so many people want a risk-free asset. They don’t care about the interest rate. They just want the safety.

Also, one of the huge sources we used to have of AAA credits was the mortgage sector: Fannie Mae, Freddie Mac, Ginnie Mae, all of the high-quality banks that were AAA issuing mortgage paper, they don’t exist in today’s depressed housing markets.

Related Reading:

Related Articles on INCOME