Perspective on InvestingNovember 2012
Seeking Income? The Stock Market May Be Your Best Bet
A series of macro-level events have been testing investors’ confidence over the past several years. Most notably, concerns about the slowing global economy, the looming fiscal cliff, European sovereign debt and a slowdown in China have increased market volatility and overall investor fear.
Despite strong U.S. equity returns since the 2008 credit crisis, uncertainties have caused many investors to keep their money in the bond market, which has historically been perceived as providing greater safety. This heightened investor demand for bonds, combined with the Federal Reserve’s programs designed to keep rates low, have forced bond yields into rock-bottom territory. In fact, the 10-year U.S. Treasury bond ended October with a low yield of 1.72%. Yields on short-term bonds continue to hover near 0%.1
DIVIDEND-PAYING STOCKS CAN HELP BRIDGE THE INCOME GAP
While the income from bonds has all but disappeared, many corporations have been making decisions to pay dividends or increase dividend payouts to their stockholders. This shift has presented investors with the unusual opportunity to earn higher income from the stock market than from many areas of the bond market.
Over the past 15 months, the S&P 500 has consistently outpaced the yield on the 10-year U.S. Treasury bond (CHART 1). In fact, nearly 56% of the stocks in the S&P 500 are now yielding more than the 10-year Treasury.1
STOCKS WITH INCREASING DIVIDENDS CAN ENHANCE RETURNS WHILE LOWERING VOLATILITY
Stocks of companies with track records of increasing dividends have delivered an average annual return of 11.3% since 1990, outperforming the 8.7% average annual return of the S&P 500. In addition to providing higher returns, these stocks have historically exhibited lower volatility than the S&P 500 (CHART 2).2
Companies that increase their dividends often generate strong revenue, earnings and cash flow. They can therefore be more resilient when the economy softens, potentially providing some downside protection when equity prices respond to slower earnings growth. Many dividend-payers also tend to be multi-national companies that can potentially offset slowing growth in their domestic markets through their activities elsewhere.
STOCK YIELDS ARE TRUMPING CORPORATE BONDS
Not only are stock dividend yields outpacing Treasuries, investors may also find instances when dividend yields exceed yields on corporate bonds. Nearly one in three S&P 500 companies now offers a higher stock dividend yield than the average yield on 10-year corporate bonds (CHART 3).3
CORPORATE AMERICA’S VIEW TOWARD DIVIDENDS IS IMPROVING
Over the past 20 years, corporate America considered dividends anachronistic as stock buybacks and acquisitions were widely viewed to be the best use of capital. However, the past decade has been littered with failed acquisitions and buybacks that did little to boost returns.
Dividends, conversely, offer cash returns directly to shareholders and can provide insights into corporate management’s confidence regarding their company’s cash flow-generating capabilities. With firms in a much better position to raise their dividends today than they were a few years ago, some have become more receptive to adopting a dividend policy to attract investor interest. In fact, in the first three quarters of 2012, firms in the S&P 500 initiated or increased dividends 266 times, up from 259 and 187 times respectively during the same periods in 2011 and 2010.3
WE BELIEVE DIVIDEND GROWTH WILL CONTINUE TO ACCELERATE
Dividends among S&P 500 companies have historically increased at an average annual rate of 5.9%. Over the past several years, however, this rate has increased significantly, jumping to 14.6% and 16.4% respectively for the past two 12-month periods ending September 30. In fact, third quarter 2012 marked the highest quarterly dividend payout amount on record for the S&P 500 (CHART 4).3
Despite record dividend payout amounts, the average payout ratio of dividends to corporate earnings remains at historically low levels. Today, dividends represent just 30% of earnings, well below the 50% historical average. With corporate cash at almost 14% of assets—the highest level in over 35 years—corporations may still be in the early stages of a long-term reversion to dividend-focused management in our view. Given the low payout ratio, we believe dividends can continue to grow at above-average rates in the year ahead.
OUR OUTLOOK REMAINS FAVORABLE
Our view toward dividend-paying stocks continues to be positive. While the tax increase on dividends that is slated to go into effect on January 1, 2013 may reduce after-tax returns for some investors, many investors will not be directly impacted by such taxes. We believe that favorable factors, including improving corporate management attitudes towards dividends, strong profit margins, high cash levels and low payout ratios position dividend-paying stocks to do well in the coming quarters.
When seeking income from stocks, it is important to remember that the dividend levels paid by stocks are driven by decisions made by the management of the issuing corporation. There is no guarantee that a company will continue to pay or increase its dividend. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Conversely, U.S. Treasury bonds, if held to maturity, offer a fixed rate of return and fixed principal value, and their interest payments and principal are guaranteed.
Our portfolio managers are continually seeking income-generating opportunities across both the stock and bond markets for client portfolios. We encourage you to speak with your Fiduciary Trust contact for information about actions being taken in your own portfolio to meet your income needs.
1. Source: Yardeni Research Inc.; Board of Governors of the Federal Reserve System and Standard & Poor’s Corporation.
2. Source: Strategas Research Partners, LLC; Standard & Poor’s Corporation. Companies with track records of increasing dividends, deemed “Dividend Aristocrats” by Standard & Poor’s, have increased dividends every year for at least 25 consecutive years.
3. Source: Strategas Research Partners, LLC; Standard & Poor’s Corporation.
This communication is intended solely to provide general information. The information and opinions stated are as of November 5, 2012, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.
Vice Chairman and
Chief Investment Officer
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