An increasing number of money managers are pinning hopes on an asset class that tends to do well no matter what the environment.
Build an “all-weather” portfolio of large multinational companies that consistently pay dividends, they say. It’s an approach that yields income even when the stock market declines.
“Multinationals are a pretty hot button right now for a lot of good reasons,” says Tom Huber, portfolio manager for T. Rowe Price’s Dividend Growth Fundfor the past 11 years. “Our diminished economic growth prospects are not as exciting as some emerging markets, and Europe is no better off. Today it’s important to invest disproportionately in emerging markets.”
If your long-term horizon is more than five years, there just aren’t many other good choices, says Fred Taylor, co-founder of North Star Investment Advisors. “Some multinationals are paying bigger dividends than 10-year bonds, sometimes twice as big," he says, "Buy companies with meaningful dividend yields of at least 2.5 percent annually that increase seven to 10 percent a year, and you’re way ahead of the game.”
Taylor mentioned Coca Cola as an prime example. Selling around $69 a share recently, Coke has a dividend yield of 2.7 percent that has been increasing steadily at 10 percent to 15 percent a year, he said.
“They make 80 percent of their earnings overseas—in China, Brazil, India,” says Taylor. “They focus on consumers in growing economies. Shareholders don’t have to worry about Europe and the U.S. growing at barely 1 percent. You want to own companies that are selling to growing markets, that hire in countries where labor costs are a third of what they are here.”
North Star also holds Philip Morris International , which pays a 4.5 percent dividend and announced a 21 percent quarterly increase last week; Royal Dutch Shell , a 5.5 percent dividend; Bank of Montreal at 5 percent and Johnson & Johnson at 3.6 percent.
In July, a Donaldson Capital Management investment policy committee report, "Have Multinational, Dividend-Paying Companies Become the World's Safest Investment?", answered the question unequivocally:
“It is becoming clear that high-quality, multinational corporations may now be the safest investments in the world,” the report says. “They have piles of cash; significant free cash flows; modest debt loads; compete in every corner of the world, and charge a price for their services dictated by the market and not decree; pay taxes in every country in which they operate; and return a significant portion of their annual earnings to their shareholders in the form of dividends.”
The U.S. is just not the fastest growing part of the world right now, says Scott Offen, who manages the common stock investments of Fidelity Strategic Dividend & Income Fund. “There are opportunities in multinational corporations in which you're not tied to any one country for growth, and you can drive your overall revenue growth from revenue growth outside America,” he says.
Dividends have been a stock-investing staple for most of the 20th century, before falling out of favor in recent years. Since 1926, dividends accounted for 42 percent of the total returns from stocks, according to research firm Ibbotson Associates.
“For much of the past decade, they’re all you’ve really gotten,” says T. Rowe Price portfolio manager Huber.
More Reliable Than Earnings Growth
In fact, Morningstarconcluded that even in the last 20 years through 2010—a period of relatively low dividends—they accounted for 27 percent of the market’s gains.
“With two bear markets in the past 11 years, people who’ve owned dividend stocks are way ahead of the game,” says Taylor of North Star Investment Advisors.
When tech investing swept the country in the mid-1990s, dividend investing was bypassed as investors focused instead on stocks’ potential for price gains. We know what happened with the tech bubble, and now companies such as Microsoft, Intel and even Ciscoare paying dividends.
Tech companies are the poster boys these days for finally deciding to pay a dividend,” says T. Rowe Price's Huber. “They’ve come to realize they aren’t the growth company they once were, that it makes sense to start paying out. It reflects a management team focused on the shareholder, which is a pretty important indication for us.”
Taylor noted that Intel now pays a 4 percent dividend after increasing it 15 percent in the last month. And Microsoft announced this week a 25 percent dividend boost, bringing it to 3 percent. Cisco is a bit of a latecomer, he says, making its first 1.5 percent dividend payments this year.
Dividend-paying stocks are the “decathletes of the equity market,” says Fidelity's Offen. “They don’t usually come in first in any one event. But as an asset class they have tended to be consistent—and that consistency can help them win over the long term.”
According to a December 2010 Fidelity Viewpoint newsletter, growth in dividend payments often tends to be more reliable than earnings growth. Since 1946, dividend growth rates have had a standard deviation of 6 percent, compared with 16 percent for earnings growth rates.
Fidelity notes how dividend payments can help offset price declines. In the previous decade, while prices of stocks in the S&P 500 fell an average 2.3 percent annually, the index’s annualized total return fell only 0.5 percent, meaning that dividend income contributed 1.8 percentage points a year to the total return.
“There’s still a perception that dividend-paying companies are no longer growth companies, that if they return the money to investors it means there are no good opportunities for them to grow,” says Huber. “If a company is growing 20 percent a year, the chances of it paying a dividend are low, but we balance out expectations, especially in the current climate. If a company is paying a dividend and growing at a 5 to 7 percent annual range, we think it’s a healthy level of growth.”
Ten thousand baby boomers a day are reaching age 65, Taylor says. “What are they going to live on? Not money market funds or T-bills. Their homes are no longer ATMs. Social Security and Medicare are in jeopardy. There aren’t any pensions and they haven’t saved enough to retire," he says. "They’re going to have to work longer and put money into something that produces meaningful income. The only good alternative they have is to own these kinds of companies.”
Focus on companies that are selling to Latin America, China, and India, says Taylor, “where a burgeoning middle class wants our goods. A weak dollar, if it continues, keeps our goods cheaper. The wind is at the back of dividend-paying multinationals for all those reasons.”