Few market opportunities have offered 10 percent growth or more for the past three years. Not China. Not U.S. GDP. Not U.S. earnings growth, either. But U.S. stock dividends have been on a tear, posting three consecutive years of 10 percent growth or more.
That record dividend run, which reached $351 billion last year, is finally showing signs of exhaustion. S&P data projects that—barring a new, and unlikely, dividend surprise, like a Google or Berkshire Hathaway—U.S. dividends will fail to keep the streak alive this year. Currently, dividend growth is running behind the pace of the previous three years.
Howard Silverblatt, senior index analyst at S&P, said, "Ten percent will be difficult to hit. We're at a record level, but growth has trimmed down, partly due to energy and nervousness over the economy," he said, adding, "Outside of Google or Warren [Buffett] deciding to spend, who can get us there? If I had to bet, I think we will come up short of 10 percent," the S&P analyst said.
It's going to be close. In another study out today, Henderson Global Investors found that in the second quarter, underlying U.S. stock dividend growth, which excludes the impact of currency, was at 9.3 percent and reached a peak level in terms of overall payouts to investors.
S&P looks at another measure—indicated dividend rate or, in other words, a company's current declared rate—and how that is trending. In July the indicated dividend rate was up 5.6 percent year-to-date. The easiest way to think about this difference is to think of a dividend as a paycheck. An investor received 9.6 percent more in their "raise" in Q2 2015 vs. Q2 2014. But the Q2 raise this year, as measured by the indicated dividend rate or "how much you made this week," is running at 5.6 percent.
Silverblatt said there are two reasons he isn't optimistic about keeping the record dividend run. First, many of the major annual dividend events occur in the first half of the year, from banks to Apple and Exxon Mobil. Second, the broader numbers suggest a slowing in dividend exuberance, with the number of stocks increasing dividends slowing down and many more decreases this year through the second quarter than last year.
There were 562 dividend increases reported during the second quarter of 2015, compared to 696 increases reported during the second quarter of 2014, a 19.3 percent decrease, according to S&P. More troubling, 85 companies decreased dividends in the second quarter, compared to 57 in the first quarter. That represented the highest level of dividend decreases since 2009. And that's an important annual marker.
In 2009, dividends paid out by U.S. stocks hit "rock bottom" of $196 billion. Just a year before, in 2008, dividends paid out were $248 billion. The good news is that the overall numbers this year will still be huge, with S&P predicting $386 billion in dividends paid, twice the recession level, and a record for dollar value paid out in dividends, which is a huge "paycheck" for U.S. investors.
But that's an easy number to hit, and when the dividend increases begin slowing, it is a reason for investors to worry about that paycheck's future. "We start looking at growth rates, because all it takes is a one-penny increase to see a record quarter in dollar terms," Silverblatt said.
Silverblatt said the dividend rally has run its course because it's doubled from the recessionary bottom, and that's not a bad thing. In fact, it's generally better for investors to not see such big dividend swings, since a dividend is the stock market equivalent of a paycheck and many investors saw that paycheck go down from 2008 to 2010 much more than they were prepared for. "You can't make up that lost paycheck money now. So which would you rather see in a paycheck? Big ups and downs or stability?" he asked.
"If you are looking for strong growth, it's over," the S&P analyst said. "The big jump we got—we won't get it again—but you don't want to get it the same way you did. ... Dividends have doubled from the bottom ... Should they be growing at 10 percent?" Silverblatt said. "The priority of companies is to maintain profitability."
Henderson Global data shows that since 2009, U.S. dividends have increased by 86 percent, "a pretty amazing figure when you think that the economic recovery has been relatively slow compared to other recoveries with steep GDP increases," said Ben Lofthouse, global equity income manager at Henderson Global.
Energy, unsurprisingly, is the biggest culprit in recent declines, representing 45 percent of dividend decreases in the second quarter. Oil hasn't been at its current low since the recession in 2009. "Energy stocks are hurting and will hurt more," Silverblatt said. "Any income from oil and gas is going down. ... Down and going downer."
Lofthouse noted that dividend trends tend to last longer than investors expect, whether it is up or down, and that's likely to be most in evidence in the U.S. energy sector as cuts continue.
The message to investors isn't one of alarm. After all, this year will still represent another record year in total dollars paid out to investors from stock dividends. But the slowing does mean investors should be looking to more stable dividend payers.
Silverblatt said companies that have increased for at least five to six consecutive years are a good place to begin, because that typically suggests that a dividend has become part of the company "culture" and increases are part of the long-term game plan.
Silverblatt also cautioned investors from looking at the highest-yielding dividend stocks as the best options. "A high yield is not a good sign," he said. "Remember the dogs of the Dow? Just because it's paying today doesn't mean it will continue to pay tomorrow," he said. Investors shouldn't look just to earnings when reviewing the reliability of a dividend, but to a company's cash-flow statement.
Keys to sustainable dividend payers
At least five to six years of consecutive payments, which indicates company intends to keep dividends as part of its culture.
Combination of strong earnings AND cash flow. Current earnings alone isn't a guarantee that dividends will keep getting paid.
Don't automatically look to the highest-yielding dividend stocks, attractive as they may be. Higher yield is not synonymous with "best" long-term dividend reliability.
Large-cap stocks have better history with dividends than smaller issues.
The most obvious way to filter dividend payers is between large-cap and small-cap companies. Big-cap companies have a much higher tendency to keep paying, S&P data shows, with 84 percent of large-cap stocks offering a dividend versus only 46 percent of small-cap stocks. And that might be where investors find more negative surprises with recent dividend winners. Silverblatt said many of the increases in recent history have come from smaller stocks, especially in energy and related commodity sectors, such as industrials and materials, but now many of these stocks have gone down. "They can't do as much now," he said.
Lofthouse has a similar view of the U.S. dividend market. He said it's better to buy the sustainable dividend payers and companies that are more attractively valued than to focus on the highest-yielding dividend stocks. A dividend investor, by nature, should be looking for a reliable yield, first and foremost.
Lofthouse said while Henderson is not negative on the U.S. market and dividend opportunity, it's hard to ignore the fact that the U.S. is now one of the most highly valued markets in the world.
U.S. investors will probably still see some of the best dividend growth, because the payout ratio isn't particularly high, Lofthouse said. Even as the U.S. leads dividend increases, its average yield has always been much lower than overseas developed markets, at a roughly 2.5 percent yield versus 3.5 percent for Europe and 4.5 percent in Australia. But he added, "Dollar for dollar, you can get more income elsewhere in the world at this point on a percentage yield basis," Lofthouse said. "But I'm not worried about growth in the U.S. other than in energy."
Henderson does find investors looking more to overseas markets as a way to diversify dividend payers. From a tax point of view, it's hard to buy individual stocks from other markets paying dividends. "It's not what you make; it's what you keep," Silverblatt said. Global dividend funds are a way to diversify dividend streams and manage tax implications.
While the strength of the U.S. dollar exacted a big toll on global dividends in the second quarter, roughly $52 billion in a currency loss, the underlying dividend growth from overseas markets is healthy, Henderson reported. Europe is on pace for 5 percent to 6 percent dividend growth, which Lofthouse described as "pretty impressive." In particular, he cited European financials that are years behind the U.S. in recapitalizing and returning capital to shareholders through payments like dividends.
"We're seeing increases from banks that weren't paying dividends. They just started again after several years of building capital and now feel they can increase share returns," Lofthouse said. Another advantage of a healthier European bank market is that unlike in the U.S., where regulators cap the amount of capital that can be returned to shareholders through dividends, in Europe banks are guiding to as much as a 50 percent dividend payout, and more focus on dividends vs. buybacks. "Dividend growth on the Continent has just started, and it's taking big steps," the Henderson Global manager said.
Lofthouse is also eyeing two markets where government policy is encouraging companies to return more capital to shareholders: Japan and South Korea. South Korea has a relatively low payout ratio, roughly 18 percent to 19 percent of capital, versus as much as 40 percent in the U.S. and more than 50 percent in the U.K., but there are recent signs that corporations in South Korea are taking government statements on return of equity to shareholders seriously. Hyundai and Samsung are among the South Korean companies to watch as indicators of this market warming up to dividends. Hyundai, specifically, increased its dividend significantly in the first half of the year.
Lofthouse said there is an important similarity between the U.S. and South Korean tech sectors in that both have what he described as underutilized balance sheets, though the payout ratio remains much lower from South Korean companies that do offer a dividend. And he said whether U.S. or South Korean tech companies, both are trading at price-to-earnings ratios lower than a decade ago.
Japan, meanwhile, recently introduced an index that focuses on return of capital, the Nikkei 400, and that is significant because it is also not a market well known for a focus on return of capital to shareholders historically, Lofthouse said.
These moves are from a low base, so can appear bigger than they are in dollar terms, but they are "turning points," according to Lofthouse.
"Investors are desperate for yield, particularly in slower growth areas," Lofthouse said. "More pressure is being placed on companies if they have a low payout ratio, asking why they are not returning more," Lofthouse said. He said while activist investors are already entrenched in battles to return more capital to shareholders in the U.S., the trend is beginning to show up overseas as well, and in the current environment it doesn't take much to gain support from shareholders.
"Sitting in cash earning a few basis points is not helpful to return on equity metrics," Lofthouse said.