Thursday, March 7, 2013

The Case for Owning Blue Chip Stocks That Pay Dividends and Periodically Increase Them is Very Strong

For long term individual investors, owning the shares of solid companies that are paying and increasing their cash dividends are the best performers over time.

And today dividend payers offer a yield which is already greater than interest on bonds and other fixed income instruments. It's one of those 'inflection points' where stocks that pay dividends should replace bonds in individual portfolios for the next several years and perhaps decades.

That's my approach and it's worked well for me. It will for others, too.

Shaking the Money Tree is subtitled 'Stocks of companies with high yields, low payout ratios and a history of raising dividends consistently outperform:'

"Dividends are becoming more important to total stock returns because companies are diverting a rising portion of their profits to them. Yield hunters should focus on companies with plenty of potential for payment growth. . . .

{PERSONAL NOTE: I own shares of such solid blue chip companies as Pfizer, Merck, Johnson & Johnson, Microsoft, Intel, Pepsi, Coke, Procter & Gamble, Wal-Mart, Exxon, GE, IBM, Wells Fargo, JP Morgan, US Bancorp, Apple, Nucor, BB&T and lots of other solid companies. Almost all of these companies already provide attractive yields and additional annual increases should deliver yields well over 6% of their CURRENT PRICES within the next several years.

In fact, many of these blue chips already yield more than 3%, and big banks like Wells Fargo, JP Morgan and US Bancorp should be getting the green light from the Federal Reserve's latest stress test analysis for additional dividend increases during this year.}

In February, typically the biggest month for dividend increases, 77 companies in the Standard & Poor's 500 index raised their payouts, the most in data going back to 2004. Payments now total 36% of index profits, up from 29% two years ago, but well below the historic average of over 50%. "We could see 40% soon so long as profits remain strong," says Howard Silverblatt, an analyst at S&P.
Company cash balances are at record levels—more than $1 trillion for the companies in the S&P 500—and most are sitting in low-yield investments. Companies can buy back stock with their cash, and many do, but on the whole, the pace of recent repurchases suggests companies are more interested in offsetting the effect of employee stock option awards than reducing their share counts, says Silverblatt.

Acquisitions are another option for cash, but they don't typically work out well for shareholders.

Following heated bidding contests, the winners tend to underperform the losers by 50% over the following three years, according to a study last year by professors at the University of California at Berkeley.

Dividends help reduce the temptation of managers to do deals, which helps explain why dividend-paying stocks do well over long time periods. Payments don't magically add to returns; on the day they're made, share prices are reduced to reflect the outgoing cash. Yet from 1972 through 2011, dividend payers in the S&P 500 returned an average of 8.6% per year, versus 1.4% for nonpayers, according to Dreyfus, a mutual-fund manager owned by BNY Mellon. Companies that raised their dividends did even better, returning 9.4%.

The dividend yield for the S&P 500 stands at 2.1% based on the past four quarters of payments. But if profits grow just 5% this year (Wall Street's 15% forecast looks overly rosy) and dividends nudge up to 38% of profits, shareholders will collect a 2.6% yield. Either number looks attractive next to the 10-year Treasury yield of 1.9%, particularly because dividends, unlike bond coupons, can grow over time.

Juicy yields abound. More than 100 companies in the S&P 500 yield at least 3%. Stock buyers shouldn't simply grab for the highest yields, however, because those can signal that investors anticipate a dividend cut, which can send a stock price tumbling. Better to look for healthy yields where the payments consume only a modest portion of profits. Between August 1996 and August 2012, "high-yield, low-payout" stocks returned 13.4% a year in the U.S., versus 8.1% for the S&P 500, according to research by Credit Suisse. The pattern was the same across stock markets around the world."

Summing Up

Bonds are going to be replaced by blue chip dividend paying stocks as the investment of choice for lots of investors, individual and institutional as well, during the next several months and years.

As that transition from bonds to stocks takes place, it should help drive stock prices even higher. That's simple supply and demand at work.

So getting into or staying with blue chips that pay good dividends now will only increase the yield on cost of those holdings as the share prices increase and dividends grow.

That will safeguard investors against potential inflationary conditions down the road, which always work to the detriment of bond holders.

It's just math.

That's my take and it's my plan, too.

Think about it.

Thanks. Bob.

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