Tags: Dividend | Stock | Shock | invest

Build Yourself a Cushion Against Dividend Stock 'Shock'

Monday, 06 Aug 2012 07:22 AM

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Are dividend-paying stocks the future of income? It certainly can appear that way, judging strictly from the numbers. Yet investors would be wise to build themselves a cushion against dividend stock “shock.”

Interest rates in many developed countries are scraping bottom, even showing up as negative yields on some government short-term bonds — in effect, institutions are paying to hold public debt.

Meanwhile, major central banks have gone on a printing spree, one that they claim can be reversed. While that remains to be seen, the immediate result is that savers and retirees are getting nearly zero on their hard-earned portfolios.

As a result, where folks once socked away cash in certificates of deposit (CDs) or money-market funds easily earning 5 percent, they now find the cupboard is bare. A dip in rates to offset a recession is understandable; yet some fear that zero is, as one famed bond fund guru has put it, the “new normal.”

That has usually staid investors plunging into equities in search of yield. The S&P 500 Index currently pays just under 2 percent. While disheartening, that handily beats the 10-year Treasury bill.

Meanwhile, the price-to-earnings ratio (P/E) ratio of the broad stock index is at 16, just a hair above its long-term median. Stocks are not cheap, by historical standards, but nor are they pricey. Investing in equities now is by no means the risk it was, say, during the dot-com days.

"Low interest rates and deposit accounts are becoming less attractive to investors," said Tom Stevenson, a director at global money manager Fidelity Worldwide Investment, in a recent report.

"Another reason for the shift is that baby boomers are retiring and prefer secure income, even if it is less than the returns of speculative growth. Income yields on blue-chip equities are higher now than the 15-year average, wherever you look across the world."

All in on equities, then? Unequivocally not. Stocks may or may not be a good buy today, but there isn’t nearly the same margin of safety offered just a few years ago as the markets plunged. It pays to wait for lower prices if your expectation is to build a portfolio of buy-and-hold anchor positions for the long haul.

Not all dividend stocks are remotely equal, either. Research has shown that the nosebleed-level, double-digit yields commonly found in real-estate and energy trusts are notoriously hard to sustain. The risk is twofold: The dividend could be cut, and the price could fall as investors flee a declining dividend.

Rather, advisers recommend that conservative investors seek solid, blue-chip firms with lower yields but long track records of raising dividends.

One shortcut to finding those stocks is to get a good “cheat sheet.” Standard & Poor’s has one, which it calls the S&P Dividend Aristocrats Index. Its members are currently in the S&P 500 and have increased dividends for at least 25 consecutive years.

The current “aristocrats” lists includes in its Top 10 holdings Walgreen (WAG), HCP (HCP), Leggett & Platt (LEG) Cintas (CTAS), Johnson & Johnson (JNJ), AT&T (T), Wal-Mart Stores (WMT), McGraw-Hill (MHP), McCormick (MKC) and Abbott Laboratories (ABT).

At mid-2012, the five-year price return on its constituent stocks came to 3.24 percent, but the total return — counting dividends paid — equaled 6.5 percent. Not too shabby in an era of low bond rates.

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