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Investors Send Message: Pay Us or End Up Like Intel

Intel’s plunge since announcing its $7.7 billion acquisition of virus software-maker McAfee should be considered a message to all CEOs out there. Investors worried about the uncertain economic outlook, not to mention already jittery coming off a lost decade for equities, do not want executives to get cute with the record cash on their books. They want dividends.

“Investors doubt that companies can be trusted to reinvest earnings and create value,” said Morgan Stanley strategist Jason Todd in a note. “Companies are better off enhancing the payout ratio and returning money to investors, something we have yet to see in the current cycle.”

Todd points to a rare occurrence in the market taking place that signals the beginning of a period where dividend yield will take on a greater and greater part of equity returns. Investors have piled into Treasurys in lieu of stocks, pushing the 10-year Treasury yield almost below the actual dividend yield of the stock market. They are effectively saying they would rather get paid these rock-bottom bond returns than trust Corporate America to consistently enhance value.

The yield on the 10-year Treasury, which fell this week to a 6-month low of about 2.6 percent, is nearing the S&P 500’s aggregate dividend yield of 2.1 percent. This unusually low spread, which actually went negative earlier this year, signals “an outlook for weak long-term earning growth that leaves a reduced possibility of P-E expansion, meaning that dividends have to be a dominant part of total returns,” according to Morgan Stanley.

Intel is not alone in getting punished for making a move besides returning cash to shareholders. The S&P 500 is down for a second straight week even though the last five days have been the biggest for announced M&A since March 2006, according to Thomson Reuters.

Investors are saying to companies that it’s a no brainer in this slow-growth, uncertain environment to just increase dividends. Especially since, non-financial corporations hold a record 6 percent of their assets in cash, according to the Federal Reserve.

“I agree that we’re entering this age of the dividend,” said Steve Grasso, NYSE floor trader for Stuart Frankel and a ‘Fast Money’ trader. “You have retirees that are just looking for income now. Apple is still trusted to execute the right strategy, but they are the rare case these days.”

Grasso and Morgan Stanley’s Todd both recommend Altria , with a six percent dividend yield, as dependable dividend payer for this environment. Other names on Morgan Stanley’s list include Lorillard, which just increased its dividend today, Bristol-Myers , Pfizer, Kraft and Philip Morris .

“We have maintained for years that Intel could benefit from thinking less like Google and more like Philip Morris,” said Christopher Danely, JPMorgan’s semiconductor analyst. “A much better use of cash would have been to increase the dividend, which we believe would help the stock.”

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