Considering they make up 50% of average investor returns, Vitaliy Katsenelson of Contrarian Edge says investors should pay more attention to dividend-paying stocks.
If I were a dividend, I’d fire my press agent. I’d be jealous and feel neglected because stock prices get a lot more attention than they deserve. The only time dividends make headlines is when they get reduced, because dividend cuts (or omissions) often go hand in hand with stock price declines.
But if you were fortunate to be alive for the past 100 years and had your money invested in the stock market, half of your returns would have come from dividends.
However, the above statement needs an important clarification: It sometimes takes decades for investors in broad stock market indexes to obtain “average” returns.
My research leads me to believe we are in a long-lasting sideways stock market. During the past three sideways markets, dividends were responsible for more than 90% of stock market returns. Yet the current dividend yield of the S&P 500 index is only 2.1%, less than half of what stocks yielded, on average, over the past century.
A few months ago, a client asked if we could come up with a defensive stock portfolio that would yield more than 7%. In an environment in which the Federal Reserve has let loose a jihad on interest rates and carpet bombed anything even remotely resembling yield through its purchase of riskless (or near-riskless) instruments of all durations, I thought it was not doable.
To my surprise, we have been able to identify a diversified portfolio of 20 stocks that meet the 7% hurdle. Half of the portfolio is in European (mostly multinational) stocks, a quarter is in Master Limited Partnerships, and the rest is in plain-vanilla US equities.
Here are two stocks that we are considering:
Vodafone (VOD) is one of the largest global mobile phone companies in the world and yields more than 8%, counting annual recurring “special” dividends. It has an A-rated balance sheet, and it can pay off any annual debt maturity from its ample free cash flow. In addition, at some point Europe will come out of what seems to be a perpetual recession, and Vodafone’s earnings growth will accelerate. The company’s crown jewel—its 45% stake in Verizon Wireless—will be monetized. The Indian market, where Vodafone is a big player, will continue to improve, and the company will start earning a reasonable return on investment there. Last, our societal addiction to being able to access the Internet anywhere at any time on any device will kick into ever-higher gears, and data sales will accelerate Vodafone’s revenue growth.
Ekornes (EKRNF) is a Norwegian manufacturer of pricey furniture that is sold all over the world. Despite manufacturing in high-cost countries like Norway and the US, the company is still achieving an impressive return on capital. It has no debt and a cash-rich balance sheet and remained profitable even in the midst of the recession. Its stock sports a yield around 7%, which will likely go up once the situation in Europe normalizes.
Analysis of high-yielding stocks should come with a warning label: Dividends are only part of the equation, and one’s analysis of a high-dividend stock should not be any different from that of a low-yielding one. After all, sustainable high-dividend yield is just a by-product of a company’s low valuation (it usually serves as a good indicator of value) and capital allocation decisions.
Once you find a company with a high—and sustainable—dividend yield, its price-earnings ratio has to work a lot less hard for you to receive a good future return.
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