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‘Dividend growers’ on the rise

by Community Manager

‎05-14-2014 10:44 AM

Market CommentaryBy Bob Landry, executive director portfolio manager

 

For the better part of a year now, the dominant conversation regarding U.S. stocks has focused on the widely shared belief that they appear overpriced based on fundamental valuation metrics, such as price-to-earnings and price-to-sales. We count ourselves among those who share that belief, and as a result, our portfolios are currently underweight both U.S. large caps and small caps.

 

But despite the consensus that investors are paying too high a price for earnings, the Standard & Poor’s 500 index of large U.S. companies keeps rewriting its record books. During Tuesday’s trading, the S&P 500 cleared the 1,900 mark for the first time before closing just a few points short of that level, yet still at a new historic high. Concerns about overvaluation may be nagging at the market, but they’re not enough to stop the S&P from running up a string of 11 straight months now (and 15 of the past 16) in which there has been at least one all-time record close.

 

That said, there are usually attractively priced stocks available even when the market as a whole is less appealing. One of the places where we are finding long-term opportunities is among companies that are significantly increasing their dividend payments.

 

Don’t confuse these “dividend growers” with companies already paying high dividend yields. Those that fall into the latter category, most notably utilities and telecom providers, have seen their share prices bid up in recent years by investors desperate to generate income during a prolonged period of rock-bottom interest rates. Dividend growers typically have lower yields, but those yields are rising at a much faster pace, in some cases more than 10 percent a year. This growth can increase the total return on these stocks, which in turn can increase their prices.

 

Back in the day, stocks were judged largely on their dividend payments, but eventually this focus faded as price appreciation rose as a priority. Persistently low interest rates, however, have helped shift the spotlight back on the value of dividends. In 2012, according to S&P, dividend income accounted for 5.6 percent of per-capita personal income, up 60 percent from two decades earlier, while interest income per capita has been cut nearly in half to 7.4 percent. Adjusted for inflation, the dollar value of dividend income grew fourfold over the same period.

 

 

Even with all of the growth in recent years, U.S. companies in the aggregate are still paying out a relatively low percentage of their profits in the form of dividends. One could make a good case for that percentage going up, as shareholders agitate for more current return on their investment and high stock prices reduce the attractiveness of share buybacks and merger activity.

 

We’re finding well-priced dividend growers in select corners of the U.S. market that are not traditional sources of yield, such as the energy, health care and technology sectors. Not long ago, many of these innovative companies were rapidly growing and reinvesting their free cash flow to expand their operations. Now they’re maturing businesses with fewer reinvestment needs, which frees up some of their still-sizable cash flow to be returned to shareholders in the form of higher dividends. The dividend yield for such companies is usually under 3 percent but is growing at least 10 percent annually.

 

If history is a guide, the improving U.S. economy stands to further raise corporate earnings, but expectations are that interest rates will also rise. This could be detrimental to above-average dividend payers as income-oriented investors return to the bond market for yield, and stock investors focus on growth companies benefiting from the stronger economy.

 

We think dividend growers could hold up better than the high dividend payers in a rising-rate environment. They may not be as adversely affected by rate increases, and the fact that they offer the prospect of increasing returns via escalating dividends could serve to enhance their appeal to investors.

 

USAA Investments Managed Portfolio Outlook

Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. While signs point to continued recovery of the U.S. economy, valuations are stretched and profit margins are near record highs. The USAA Income Stock Fund seeks dividends and dividend growth as contributors to total return.

 

We are tactically underweight fixed income, primarily to fund a deployable cash position. Within fixed income, we prefer areas of the market that are more credit-sensitive and less sensitive to changes in interest rates, such as investment-grade corporate bonds and high-yield bonds. The USAA Intermediate Term Bond Fund and the USAA High Income Fund fit this profile.

 

We are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund provides potential protection against the risks of long-term inflation.

 

We are overweight non-U.S. developed markets and emerging markets based on relative valuations. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. Along with compelling valuations, they offer an interesting long-term prospect for growth. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.

 

As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for your individual goals, objectives, risk tolerance and time horizon.

 

This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.

 

Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Contact us at 1-800-531-8910 for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.

 

Investing in securities products involves risk, including possible loss of principal.

 

Past performance is no guarantee of future results.

 

As interest rates rise, existing bond prices fall. Non-investment grade securities are considered speculative and are subject to significant credit risk. They are sometimes referred to as junk bonds since they represent a greater risk of default than more creditworthy investment-grade securities. 

 

Some income may be subject to state or local taxes or the federal alternative minimum tax.

 

Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Emerging market countries are most volatile. Emerging market countries are less diverse and mature than other countries and tend to be politically less stable.

 

The S&P 500 Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange.

 

Standard & Poor’s 500 Index and S&P are registered trademarks. The S&P 500 Index is an unmanaged index of 500 stocks. The S&P 500 focuses on the large cap segment of the market, covering 75% of the U.S. equities market. S&P 500 is a trademark of the McGraw-Hill Companies, Inc.

 

The Russell 2000® Index is an unmanaged index which consists of the 2,000 smallest companies in the Russell 3,000 Index, and is a widely recognized small cap index.

 

USAA or its affiliates do not provide tax advice. Taxpayers should seek advice based upon their own particular circumstances from an independent tax advisor.

 

High double digit returns are attributable, in part, to unusually favorable market conditions and may not be repeated or consistently achieved in the future.

 

Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.

 

The Real Return Fund may be subject to stock market risk and is non-diversified which means that it may invest a greater percentage of its assets in a single issuer. Individual stocks will fluctuate in response to the activities of individual companies, general market, and economic conditions domestically and abroad. When redeemed or sold, may be worth more or less than the original cost.

 

Managed Accounts is a service of USAA Investment Management Company (USAA), a registered investment adviser and broker dealer.

 

Diversification does not guarantee a profit or prevent a loss.

 

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