Six weeks of dropping stock-market indices and dimming prospects for the global economy have investors looking for a safe harbor. That may very well be summed up in one word: dividends.
More than in many years, especially since the Great Recession, dividend-yielding stocks are a crucial consideration for investors.
Dan Newhall, a principal in Vanguard’s Portfolo Review Department, is among the overseers of the Vanguard Dividend Growth Fund(VDIGX_), which has $5.7 billion in assets. He says there has been “an incredible amount of interest in anything that is income-oriented.”
That’s because a sluggish economy has produced slow inflation — outside of energy and food prices, he says. Plus, Newhall says, investors have shied away from the equity market.
But therein lies the dilemma. Investors want to get back into the equity market because their CDs, bank accounts and money markets aren’t yielding much and even if they did pretty well with bond funds, those yields have also come down. However, looking for income brings investors face-to-face with big risks in the stock market, which has fallen 7% in the past month, as measured by the S&P 500 Index. That leaves the benchmark index up only about 2% for this year.
Newhall says that’s why many are paying more attention to dividend-producing stocks and funds such as the Vanguard Dividend Growth Fund.
The fund invests in “very high-quality” dividend-paying companies that “have attractive prospects and have provided very appealing downside protection,” he says. The test of that philosophy came in 2008 when the fund was down 26%. “It was painful, he says. “But the market was down 38%.
Newhall says Don Kilbride is the portfolio manager at Wellington Management Co. who looks to construct and build the Vanguard Dividend Growth Fund’s portfolio as one that is capable of delivering a growing stream of income over longer periods of time. His objective is to have those dividend payments exceed inflation by about 3% a year on average.
The approach to finding “high-quality” dividend yields has evolved over the years.
“It is not too far in the past where people didn’t pay much attention to dividends,” he says. “Frankly, companies and their management weren’t very incentivized to pay dividends, especially with stock-option plans that were based entirely upon stock price appreciation and that is how they were getting compensated. They didn’t really see the benefit. They’d rather plow everything back into growth projects that may or may not deliver the kinds of returns that they should deliver, or buy back stock.”
One reason the portfolio has done well is that the companies have been doing well.
“Despite the financial crisis, the companies that we own in the portfolio have averaged dividend growth of just under 13% a year for the last five years,” he says. “He has been able to build a concentrated portfolio of companies that are really performing right now.”
Bruno del Ama, CEO of Global XFunds, a New York-based firm with $1.7 billion in managed assets, presided over the launch of the new Global X SuperDividend(SDIV) ETF on Thursday. The exchange traded fund, which seeks to replicate the Solactive Global SuperDividend Index, debuted, in part, as a response to the demand and focus on dividend-paying stocks.
“We are in an interest-rate environment where the interest rates are so tight that it’s very difficult to get any significant income from fixed-income securities,” del Ama says, adding that demographic trends make this a top-of-mind issue.
“You have more and more people who either are nearing retirement, or just retired,” he says. “They suffered significant stresses in their portfolio during the 2008 period and find themselves with less capital and some losses. Everybody has a longer life expectancy, so what can you do to preserve the capital but at the same time generate income? That is the big-picture driver behind the demand for income-related products.”
The strategy behind the two funds offers some strategies for investors to consider.
The two funds take different approaches. The Vanguard Dividend Growth Fund holds a carefully weighted portfolio of about 50 companies, mostly domestic, that are deemed top performers in terms of dividend yield, underlying stock price and the “high-quality” nature of the firms and their balance sheets.
Quality means a company that may suffer from volatility and uncertainty but it won’t “go belly-up or need a government bailout,” Newhall says.
In the past, financials were the sector that dividend-seekers flocked to. That’s no longer the case, especially with government regulators restricting dividend payouts for bailed-out banks.
“Those are two banks that grow dividends well over 100% this year,” Newhall says.
Among the top VDIGX holdings are Automatic Data Processing(ADP) (with a dividend of $1.44 and yield of 2.80%), Exxon Mobil(XOM) ($1.88/2.4%), Pfizer(PFE) ($0.80/4%), Pepsi(PEP) ($2.06/3%), Medtronic(MDT) ($0.90/2.4%), Western Union(WU) ($0.32/1.6%), IBM(IBM) ($3/1.8%), Cardinal Health(CAH) ($0.86/2%) and Johnson & Johnson(JNJ) ($2.38/3.4%).
Colgate-Palmolive(CL) (with a dividend of $2.32 and yield of 2.7%) “is one we consider a stalwart of the fund,” Newhall says. “Colgate is such a great example because you look at it now and, on a run-rate basis, its dividend should increase this year about 14% and this is the 48th consecutive year of dividend growth. We’d love to fill the portfolio with 50 companies like that.”
SDIV maintains an underlying focus on diversity. It has a multi-national selection of 100 companies, each equally weighted.
“The expectation going in is that we would see a lot of concentration in financials and utilities,” del Ama says. “When we came back with their list of the top-paying companies we found that we had a ton of consumer companies. We have a pretty broad range of companies.”
REITs comprise 22% of the portfolio, followed by consumer discretionary (16%), telecommunications (16%), financial services (10%), utilities (8%), banks (5%), consumer staples (5%), energy (5%), industrials (5%), insurance (3%), technology (3%) and health care (2%).
International company and currency holdings break down among the U.S. (32%), Australia (24%), Great Britain (10%), Canada (6%) and Singapore (4%).
The equal weighting “materially diminishes the risk of any one company cutting or significantly decreasing their dividends if the get into financial difficulty,” del Ama says.
A key selection criteria for both funds is not just current yields, but companies that have the ability to grow that yield.
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