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Dividend Stocks for Income (Marketwatch)
Income hunters: Bank on this dividend stock play
BY MarketWatch — 6:15 AM ET 06/13/2013
SAN FRANCISCO
(MarketWatch) -- Corporate America is flush with cash, but to some investors,
businesses are flushing money away by paying dividends. They'd rather see
companies buy back stock. Of course, others want the dividend income -- in
regular and greater amounts.
It's a big shareholder divide, one made even wider now that rising bond
yields have slammed utilities stocks and other dividend darlings. (Read more:
Where to put your money when bond yields rise:
http://www.marketwatch.com/story/where-to-put-your-money-when-bond-yields-rise-2013-06-07.)
Weighing dividends vs. buybacks is a good problem to have -- like deciding
whether to wear diamonds or pearls. Yes, these are two completely different uses
of capital -- dividends assume you'll use the money better, while repurchases
signal potential buyers that the company's shares are attractively priced.
But companies with the option to spend money on either of these fashions are
fundamentally sound.
"Companies that pay high dividends or are returning cash to shareholders
through buybacks are inherently healthy companies," says Chris
Brightman, head of investment management at Research Affiliates LLC,
which creates indexes for exchange-traded funds and mutual funds.
Even better: Paying dividends and repurchasing shares.
Many companies actively increase dividend payouts and implement buyback
programs. Dividend growers offer investors a steady stream of cash, while
buybacks tend to boost a company's stock's price. It's a marriage of opposites,
but it works.
Healthy and wealthy
So, how do you find these stocks?
Brightman says the first order is to eliminate low-quality companies from
your dividend and buyback screen. These stocks seem attractively priced but in
fact are a set-up for what's known as a "value trap."
Instead, he points out, look for companies with below-average volatility and
debt relative to their industry, plus above-average debt coverage -- meaning
there's more than adequate cash to handle obligations.
"That's a pretty strong indication that the company is not distressed,"
Brightman notes.
From that group, pick the highest-yielding stocks and then check to see which
have share-repurchase programs.
At MarketWatch's request, Brightman compiled a list of 10 stocks he called
"healthy companies priced at relatively high yields."
As of May 31, these included Exxon Mobil ( XOM
) .
Indeed, this year has seen a buyback frenzy, on pace to finish second only to
2007's record, according to research firm Birinyi Associates.
The 10-largest buyback authorizations so far through May came from companies
that also pay dividends, including Apple ( AAPL
) .
A one-two ETF punch
If individual stock picking isn't your skill, a solid dividend-growth and
buyback strategy can be crafted using exchange-traded funds.
For example, PowerShares Dividend Achievers owns shares of companies that
have increased their annual dividend for 10 or more consecutive fiscal years --
no easy feat.
Sibling PowerShares Buyback Achievers ( PKW
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) invests in companies
that have repurchased at least 5% of their shares over the past 12 months -- not
just an announcement to buy back shares, as many companies try to get away with,
but actually forking over the cash.
Each of the two portfolios is full of cash-rich, well-known companies. As can
be expected, Dividend Achievers currently yields about 2.2%, while the buyback
fund yields around 0.9%.
Performance-wise, both ETFs have topped the Standard & Poor's 500-stock
index over the past three- and five years, though Dividend Achievers has lagged
the benchmark over the trailing 12 months. Buyback Achievers also has trounced
the dividend fund, but it's riskier -- although both funds have been less
volatile than the market itself.
Combining the two ETFs offers the best of these worlds, which in fact are
more interconnected than would appear. Dividend Achiever's top holdings include
Johnson & Johnson Chevron , Wal-Mart ( WMT
) -- of which all but AIG
are dividend payers.
The dividend ETF's high bar keeps overlap with Buyback Achievers to a
minimum. Just four names surfaced in both funds, based on a Morningstar screen:
Conoco Phillips ( COP
) .
As for results, a 50-50 split between the dividend and buyback funds would
have handily beaten the S&P 500 over one-, three- and five years, as well as
through May of this year -- with less-than-market risk. The combination's 7.7%
annualized return over five years outshines the S&P 500's 5.1% comparable
total return, according to Morningstar, and its 17% gain for the year as of
May 31 was 1.5 percentage points better than the U.S. market
benchmark.
Other dividend-growth focused ETFs to consider include SPDR S&P Dividend
ETF ( SDY
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) , which reflects the
S&P High Yield Dividend Aristocrats Index, Vanguard Dividend Appreciation ,
and the new WisdomTree U.S. Dividend Growth Fund ( DGRW
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) .
Keep in mind that dividend-growth focused ETFs and mutual funds tend to be
heavily invested in consumer staples, telecom, utilities and other traditionally
defensive sectors.
For example, the most widely traded dividend-stock ETF, iShares Dow Jones
Select Dividend Index Fund ( DVY
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) , commits almost 30% of
its portfolio to utilities, which has been the hardest-hit market sector in the
wake of rising interest rates; consumer staples and telecom also have
lagged.
In contrast, WisdomTree U.S. Dividend Growth acknowledges the stronger U.S.
economy by splitting 60% of the fund about equally among technology, industrial
and consumer cyclical stocks.
PowerShares Dividend Achievers, meanwhile, allocates about one-third of its
portfolio to defensive stocks and 25% to cyclical stocks, but adding Buyback
Achievers flips that around, trimming defensive exposure to about 25% and upping
cyclical stocks to 36%.
Remember, timing is everything; be careful of the price you pay, or you'll
pay the price. Right now cyclical shares with a yield are relatively cheaper
than utilities and other bond-like stocks -- and you can be sure that's not lost
on company directors contemplating share repurchases.
"Buy good quality companies and buy them when they're cheap," Brightman
advises. "This is not much different from what you would be instructed to do by
Warren Buffett or Ben
Graham."
