Tuesday, March 27, 2012

Dividends Projected to Rise 15% in 2012 ... Still Room to Grow

Cash dividends historically have provided as much as 50% of a company's total return.

This year dividends are being increased substantially as companies have bounced back from the depths of the recent deep recession. Let's review why the outlook for further dividend growth is still quite strong.

Dividend Investors to Get 15% Raise is a hopeful look at what's ahead for increasing cash dividend payments to shareholders:

"The dollar amount of dividend payments underlying the S&P 500-stock index should increase 15% this year . . . .

That number might prove conservative.

It takes into account dividend boosts that have already been announced, as well as anticipated announcements from companies with a long history of raising payments. It also includes Apple’s newly announced payment, which will take effect beginning in the second half of 2012.

However, the estimate doesn’t include the possibility that other cash-stuffed technology firms will follow Apple’s (AAPL) lead and announce payments....

Banks could provide even more upside . . . . Historically large dividend payers, they slashed their dividends during the recent financial crisis but are gradually restoring them. Financial companies contribute 13% of S&P 500 dividends now, up from a low of 9% in 2009 and 2010 but well below the 29% they contributed in 2007. It’s difficult to predict when banks will restore their dividends, and (S&P analyst) isn’t counting on a normalization of bank dividends in his analysis.

Dividend increases hold several forms of appeal for investors. Some make stock prices jump right away; Apple rose 2.7% Monday. Rising dividends are also linked with share price increases over the long term, because they attract more attention from income investors.

Companies that raise their dividends are more likely than others to deliver greater-than-expected earnings in subsequent quarters . . . .

Three things bode well for long-term dividend growth . . . . First, companies are aware of increased investor demand for yield. . . . Second, despite a record 22 new dividends announced by S&P 500 companies last year, only 397 of the 500 now pay dividends, versus an average since 1980 of 413.

Third, dividend payments as a percentage of company profits now stand at about 30%, versus a historical average of 52%.

There are some wild cards to look out for, however. Safe-haven bonds have recently offered a pay raise of their own–because bond prices have fallen, pushing yields higher. The 10-year Treasury yield recently approached 2.4%, versus 1.9% at the start of 2012.

If that trend continues, it could lure investors away from dividend-paying stocks, and make companies less keen on boosting payments. That seems unlikely, if only because the Federal Reserve said in January it plans to keep core interest rates “extraordinarily low” through 2014.

A larger obstacle could be taxes. The dividend tax rate is currently capped at 15%, but the cap expires at the end of this year. Without action from Congress, the maximum dividend tax rate will revert to 39.6%. If that were to happen, it might cause more companies to favor share repurchases over dividends, because the former don’t trigger taxes for investors. Or, it might cause companies to continue holding onto their profits.

For now, a 15% increase in dividend spending is welcome news, especially among working investors who are finding it difficult to secure pay raises. Average hourly earnings for workers have increased just 1.9% over the past year, while inflation has raised the cost of living by 2.9%."

Discussion and Analysis

A one time 15% raise is pretty good. A 7% raise each year is perhaps even better. And being granted a one time catch-up raise is always a nice surprise.

Compared to fixed income investments today, companies that demonstrate solid earnings and are able to pay increasing cash dividends to their shareholders are great investments.

In other words, today the cash dividends of a company frequently make the case that owning an individual stock for the long haul is a great idea. Let me explain.

Dividends are paid from a company's earnings, as is the interest on bonds.

If earnings grow at a compound rate of 7% over time, the rule of 72 posits that earnings will double approximately every decade. As go earnings, so go dividends as well.

Currently cash dividends paid by many blue chip companies yield ~3% in relation to the company's share price.

Assuming a 30 year investing horizon, that 3% will become 24% in 30 years.

There's more.

Today companies are only paying 30% of company profits in dividends compared to a historical average of 52%.

And today earnings are below historical peaks in many companies as well.

Thus, our aforesaid 24% yield on cost in 30 years could easily be more than 50% as either (1) earnings revert to the mean, (2) cash dividends paid as a percentage of earnings revert to the mean or (3) earnings compound at a faster rate than 7% annually for specific companies.

But even if none of the above occurs, compared to bond yields, a 24% cash return on an initial investment is a whopper.

And we haven't even factored in the company's inflation adjusted share price appreciation.

Thus, why would anybody buy bonds?

Why not instead buy and hold shares of solid companies that have a track record of earnings and an ability to pay solid dividends as earnings increase?

Thanks. Bob.

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