Beyond Bulls & Bears

Following the (Dividend) Yield Signs

Flush with cash on their balance sheets, many U.S. companies have increasingly been rewarding shareholders in the form of dividends over the past year. That’s good news to the many investors who have sought out dividend-paying stocks for potential relief in today’s yield-scarce environment. Alan Muschott, portfolio manager for Franklin Templeton’s Equity Group, is a vocal fan of not just dividends, but growing dividends. In a recent interview he shared his views on the dividend comeback, including technophile-favorite Apple’s announcement that it plans to declare a dividend for the first time in more than two decades. Read on to see what he had to say.

The good news for dividend devotees is that dividends seem to be steadily regaining momentum. As evidence of the trend, the number of dividend-paying companies in the S&P 500 Index has climbed to the highest level since 19991. In the first two months of the year, 429 companies in the S&P 500 increased their dividends, up 35% compared with the same period in 20111. For Muschott, an increase in the quantity of dividend-paying companies within the entire market is certainly welcome, but it’s the quality of these companies that’s most important—if harder—to measure.

Alan Muschott

“We’re looking for a strong competitive position: companies with a sustainable competitive advantage that are taking market share and have strong margins; companies that are financially solid, with strong balance sheets and investment-grade ratings by the credit rating agencies; companies that have strong cash flows, and therefore the ability to pay a dividend, grow the dividend and weather storms. We are also looking for companies that have strong management—not just the senior management; we also get to know the lower layers of management. We like to see a culture that really permeates the company, and part of that casino culture being a return of money to shareholders through paying dividends.”

In March, Apple announced it plans to initiate a quarterly dividend sometime between July 1 – September 30, 2012. The technology behemoth hasn’t paid a dividend since 1995, leading some in the financial press to dub its announcement a “game changer” for the market. The company would become one of the largest dividend-paying companies in the U.S. Muschott called it “long overdue.” To him, Apple is just another welcome example of how companies rife with cash are rewarding shareholders.

“Looking more broadly at what kind of message it sends about companies that pay dividends, we think it’s a positive one. It really validates what we’ve believed all along—that all types of companies pay dividends. Very high-quality companies, and even innovative growth companies like Apple pay dividends. We think that helps emphasize the attractiveness of dividend-paying common stocks.”

As companies emerged from the 2008–2009 financial crisis, many worked to cut costs, pay down debt and rebuild their balance sheets, stockpiling near-record levels of cash. That has helped drive the recent dividend bonanza and an increase in share buybacks too. Muschott sees even more room for companies to continue these types of actions this year.

“The returning of money to shareholders is something we expect to see continue, and in fact, if you look at the payout ratio of the S&P 500 companies right now, about 30% of earnings have been paid out in the form of dividends. That’s near a record low. If you look over the last 80 years, the average is closer to 60%2. We don’t necessarily think it’s going to get back to that level, but there certainly is a lot of room for companies to be increasing their dividends. Of companies that we focus on, more than 80% increased their dividend over the last year.”

Sir John Templeton espoused the importance of seeking out quality stocks, not just any stocks: “A wise investor knows that the stock market is really a market of stocks. While individual stocks may be pulled along momentarily by a strong bull market, ultimately it is the individual stocks that determine the market, not vice versa.”

Want more from Alan Muschott? Check out “Diving for Dividends.”

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What are the Risks?

Investing in dividend-paying stocks involves risks. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Companies cannot assure or guarantee a certain rate of return or dividend yield; they can increase, decrease or totally eliminate their dividends without notice. Investment return and principal value will fluctuate with market conditions, and it is possible to lose money.

1 Source: Standard & Poor’s. S&P 500 Index: STANDARD & POOR’S®, S&P® and S&P 500® are registered trademarks of Standard & Poor’s Financial Services LLC. Standard & Poor’s does not sponsor, endorse, sell or promote any S&P index-based product. Indexes are unmanaged, and one cannot invest directly in an index.

2 Source: Ned Davis Research Inc., April 2012.

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