Dividend Investors Are Willing to Pay Much More For a Bird in The Hand Than for Multiple Birds in the Bush

Dividends matter and a brief look at our three investment strategies reveals a remarkable symmetrical total return distribution.  All three strategies are selected from the same stock-filtering and valuation models.  Stocks are slotted into each individual strategy by our Investment Policy Committee based on financial strength, dividend yield, and rate and consistency of dividend growth.

The Income Builder Strategy -- High Dividend Yield, Low Dividend Growth

• Current dividend yield approximately 4.50%
• Last twelve month dividend growth 6.0%
• Total Return last twelve months approximately 10.0%

The Cornerstone Strategy -- Above Average Dividend Yield, Above Average Dividend Growth

• Current dividend yield approximately 3.5%
• Last twelve months dividend growth of  almost 12.0%
• Total Return last twelve month of almost 7.0%

The Capital Builder Strategy -- Low Dividend Yield, High Dividend Growth

• Current dividend yield approximately 2.2%
• Last twelve months dividend growth of approximately 15%
• Total Return last twelve months of approximately 4.0%.

A simple look at the three different investment strategies reveals that investors have been willing to pay up for higher yielding stocks.  The Income Builder portfolio with its 4.5% dividend yield has run away from the other two strategies on the basis of total return.

Cornerstone, which is our flagship investment strategy, has had good returns over the last twelve months but has under-performed the Income Builder Strategy, even though Cornerstone companies have increased their dividends at twice the rate of Income Builder companies. Finally, Capital Builder companies have had one of the best earnings and dividend performances we have witnessed in many years, yet the strategy has not performed as well as either of the two higher-yielding strategies.

What are we to glean from these data?  The obvious and most simple answer is that in this very low interest rate environment (10-year US Treasury Bonds are yielding under 2.0%), investors have been willing to pay up for higher dividend yield, while dividend growth is being discounted, if not ignored.

While the data clearly show the attraction of high dividend yields, history reveals that over longer periods companies with higher dividend growth normally outperform slower growing companies.  In short, companies that can increase their dividends at low to mid-double digit rates fall in and out of favor, but the long-term trend line of their total return growth is higher than the trend growth of slower growing companies. This means that today the high growth companies are becoming spring-loaded.  That is they are very cheap, and as the European crisis begins to subside, we believe higher growth companies will run away from lower growth companies.

Then the question becomes: when do these spring loaded companies start springing?  Our answer is we don't know.  Furthermore, we don't think anyone knows.

In keeping with the old fashioned concept of "the trend is your friend" we have tilted all of our portfolios to a slightly higher dividend yield relative to the S&P 500 than normal.  Our models tell us that the high-yield, low-growth stocks, which include many utilities, are still undervalued based on historical measures of dividend yield and growth versus interest rates.  For this reason, we believe quality, high yield stocks have room to go higher.

However, because the high dividend growth companies have become the most undervalued of all types of stocks, we continue to nibble on selected stocks, even though they are flat lining price wise.

Our best guess is that there might be as much as six more months of this symmetrical affinity for relative dividend yield. After the Fed has completed its "Operation Twist" initiative, the markets will no doubt reappraise inflationary forces and reprice long time bonds and high dividend yielding stocks.  Until then, the markets are clearly saying that they are willing to pay more for the bird in the hand than the birds in the bush.

Next time we'll talk about another high dividend yield stock that we believe is still undervalued.

         

United Technologies: The Hidden Dividend Star

United Technology (UTX) is the Dividend Star most of the simple dividend-growth filters miss.  This is because they do not raise their dividend every year. UTX takes action on its dividend every six quarters, not every four quarters, as do many dividend stars.

I have even tried to explain to the company's investor relations department that while their every-six-quarters dividend hikes has been quite predictable, that such a policy means that about every three years their annual dividends flat line. Thus, the company is not included on many lists of companies with long-term histories of consecutive dividend hikes.  No matter says the company. They like to do it the their way.

In this case who am I to push against such a winning record, just to make it simple.  UTX has one of the most consistent dividend growth records of any company I follow.  The following are their 20, 5, and one year annual dividend growth rates.

1. 20-year growth rate  11.3%
2. 5-year growth rate    12.5%    
3. 1-year growth rate    12.9%

To top it off, the estimate of UTX's three to five year dividend growth rate is just under 12%.  At that rate of growth its dividend will triple over the next ten years.  Not bad for a company that has a current yield of 2.6%.

Despite UTX's consistent dividend hikes and earnings growth over the last twenty years, the Dividend Valuation chart at the top of this page suggests that the company is significantly undervalued based on the historical relationships among its price growth, dividend growth, and interest rates.  UTX's current price (red line) is much lower than its current valuation (blue bar) and even lower yet, than our estimate for next year (checkered blue bar).

The so-called Correlation Index, which measures how tightly the average stock is tracking the major indices, has risen to as high as 85% in recent weeks.  Its normal reading is near 15%.  This means that the constant on again off again European bail out proposals have turned what is normally a market of stocks into a stock market.  What I mean by this is that almost all stocks have been caught in the maelstrom of big up and down days, which would indicate that all companies have about the same future profit and dividend potentials.  If you take a few minutes to think about this, the truth almost smacks you in the face.  The one thing we know for sure is that the future prospects are not the same for all stocks, thus, it is just a matter of time before stocks start to trade on the bases of their own unique fundamentals, not the generalized fears of the European situation, no matter how things turn out.

In this regard, we believe UTX has quite a pedigree and will ultimately break away from the pack and show it star quality..   

I own UTX.

12 Random Ramblings

Every working day of our lives we get questions.  Questions about the stock and bond markets.  Questions about how natural disasters, politics, or economic and business crises will play out in the market place.

In this weekly blog we try to keep our comments narrowly focused on our dividend investment strategy.  As we were composing our most recent quarterly letter we admitted to our readers that at times we sound like a one trick pony:  our solution for every challenge and every opportunity is always -- buy and hold quality rising dividend stocks.  In the long run we know that will work.

Yet the matters we discuss and decide at our weekly investment policy meetings cover the waterfront of issues.  In this regard, heaven help us, we are like politicians because we have to have a basic understanding and a few talking points on just about everything that is going on in the world.  

We thought our readers would appreciate our short takes on a long list of issues facing our nation and the world.  Normally, when we write these blogs or our client letters, we try to offer solid proofs for our positions.  In this piece, we are not going to do that.  We are just going to give our views, without supporting arguments.  This way we can cover a wide range of issues that you may have questions about.  It is our plan to periodically offer an update to what we are calling 12 Random Ramblings from the Investment Policy Committee.

1. Stocks are undervalued by about 25%.  Energy, Industrial, and Consumer Cyclical stocks are very cheap.
2. US Government bond yields are at historic lows, but will not rise much over the next year.
3. Inflation will fall.
4. US Corporate profits will continue to surprise to the upside, driven by business in developing nations.
5. Greece is already bankrupt, but the European Union will keep the country on life support for an extended time.
6. The market has already priced in a Greek default.
7. The US economy will not fall into recession and may surprise to the upside in the fourth quarter of this year.
8. The worldwide economy will grow by at least 3%, after inflation, this year.
9. Dr. Doom, Nouriel Roubini, has signaled better times may be on the horizon for the US and the world by putting his investment advisory firm up for sale. 
10. The average dividend payout ratio for the S&P 500, which is now, under 40%, will move back toward its 80-year average of 50% over the next five years.
11. There is still a chance that Hillary Clinton will run against President Obama if his polling numbers don't improve by December.  She would likely beat any Republican, and the stock markets would rally, not because her views are so much different than Obama's, but because the economy and the markets did so well under Bill Clinton.
12. If  Roubini is selling his company, the price of gold may have already seen its highs.

Greg Donaldson, Chairman of the Investment Policy Committee

Donaldson Capital Management, LLC

Nextera Energy: A Dividend Star on The Rise

Normally we are suspicious when old-line companies take on new names.  We have too many bad memories of the collapse of many of the new-name crowd during the Tech bubble. In rare cases, we believe changes in a company's name makes good business and strategic sense.

We believe Nextera's (NEE) name change is both an improvement over their old name, FPL Group, and an important milepost of the maturing of an exciting business strategy.

NEE changed its name from FPL Group a little over a year ago.  The name FPL Group was a change from the company's original name of Florida Power and Light and became necessary when the company began expanding well beyond Florida.

But the most important reason we like the new name is because we believe NEE is truly a very different kind of power company.  Indeed, since 1989 they have increasingly taken on a "Next Era" attitude toward electric power generation.  In the above link, they state that they now produce nearly 95% of their electric power from clean or renewable sources.  They are now North America's leader in sun and wind energy.  In addition they have a long history of safely operating nuclear power plants.  In short, today Nextera is one of the nation's top clean and renewable electric power producers.  We believe they are just beginning to reap rewards for their 20+ years of investing in alternative energy sources.

Recently, we have been adding to our NEE holdings because we believe the stock has a very bright future and our Dividend Valuation Model (above) indicates the stock is approximately 20% undervalued.

Even with President Obama's pullback on more stringent EPA emissions standards, existing clean air regulations are forcing more and more electric utilities to close old, less efficient coal-fired generating plants and abandon new coal-fired plants.  The bottom line is that many Midwestern power companies are scrambling to gain access to clean and renewable energy sources, and NEE has it for sale.

Here is a short list of other reasons why we like NEE:

1. Current dividend yield is near 4%.
2. 5-year dividend annual growth of just under 8%.
3. Projected 3-5 year dividend growth of near 6%.
4. Current dividend payout ratio is near 50%, much lower than industry average of 70%.
5. Paid a dividend since 1990
6. Increased its dividend for 15 consecutive years.
7. Stock is currently selling at a PE of 12, much lower than the industry average of 15. 
8. Company operates in 26 states mainly in the growing southern region of the US.
9. One of the most forward thinking management teams in the industry. 

NEE's exposure to nuclear power may be seen by some as a negative.  However, with Southern Company's recent application to construct the first nuclear power plant built in the United States since the 1970s, we believe there is a growing belief among many investors that nuclear power will continue to be an important low cost source of electric power. 

We own NEE and have no plans to sell it.

Greece is Burning But Many Multinational Dividend-Paying Stocks Are Still Cool

CNBC.com recently quoted excerpts from one of our blogs about the great values in dividend-paying multinational corporations.  CNBC.com's article included our views along with other money managers that are saying the same thing.  Here is the link to the article: CNBC.com.

The quote used in the article was taken from a July 29 blog written by Randy Alsman, one of our senior portfolio strategists.  Here is a link to Randy's full blog: Rising Dividend Investing.

We are happy that CNBC picked up our story-line.  We believe the evidence is conclusive that global companies have a flexibility and financial power that is being completely ignored in today's stock market.  We are particularly pleased that it is CNBC that is digging into the great story of multinational dividend payers.  CNBC and its multiple media brands have a reputation of being aimed at traders and speculators, spending little time and attention on long-term value investing. In that regard, we tip our hats to CNBC.com.  They took the time to talk with some veterans in the business who have been through crises before and believe that the current level of fear in the market cannot last.

One day the panic will subside, and when it does we believe the first place investors and even traders and speculators will go is to the financially strong, multinational companies for exactly the reasons that Randy detailed in his blog.

Yet, as we write this edition of our blog, traders and speculators are abandoning stocks of all stripes and rushing into US government bonds, driving bond prices to unbelievable heights and bonds yields to depths not seen since the 1950s.  Is there a bubble under Treasury bond prices? -- you bet!

When considering that our government is borrowing 40 cents of every dollar it spends, and is so politically stalemated that the only thing legislators can agree on is TGIF (but only if G stands for goodness), the confidence speculators are bestowing on US Treasury bonds is nothing short of amazing. 

Multinational corporations possess qualities that are not being fully appreciated or valued in today's market.  That old saying about cream rising to the top is very applicable today in our judgment.

Greece is burning.  Indeed there are signs of smoke in many countries in Europe, but the earth will still be spinning when this most recent "debt spiral" winds down.  For reasons included in the long list of attributes that Randy detailed in his blog, the safest bet we know of is to stick with with what we know and what we know is good.  That is multinational corporations that pay a generous dividend.

Thanks again to CNBC.com.  To our knowledge this is the first time they have quoted us. We are honored that they included us in their story of the merits of dividend-paying companies.

We own many multinational companies that pay a generous dividend.  

Southern Company: Our Top Pick Among the Utilities

Here's a pop quiz for you:  What are the yields on 10-year and 30-year US Treasury bonds?  Unless you are an extremely keen observer of the bond markets, my guess is you will be shocked to learn that 10-year US Treasuries now yield only 1.80% and 30-year Treasuries are yielding a paltry 2.9%.

Just think of it, if you want a supposedly risk-free investment, the highest rate available is under 3%, and to get it you have to tie up your money for 30 years and pay taxes on the income.

Rates have fallen to these levels as a result of the Federal Reserve's attempts to stimulate the economy.  In driving rates to such low levels, the Fed is essentially trying to force investors to look away from Treasury bonds toward other investments that offer a better return.  We think it will work.

The chart above shows our 20 year Dividend Valuation Model for Southern Company (SO).  The chart clearly shows that SO's price (red line) and value (blue bars) have moved in close proximity over this time frame.  The statistical correlation is above 80% and suggests that SO is approximately 25% undervalued.

Southern is one of the country's biggest and best run utilities. You might call it the Sunbelt's power company because it serves most of the southern half of the United States east of the Mississippi River.  This is key to it long-term prospects.  It is well-know that the Sunbelt climate is popular with both people and businesses.  There has been a steady migration of both into the region for the last 30 years.

We believe one of the first places investors will look as they move away from bonds is at utilities.  Utilities offer high dividend yields, dividend growth, some governmental protection, and provide a service that is essential to our way of life.  Here's the bottom line on Southern Company.

1. SO's current dividend yield is 4.5%, much more than the aforementioned Treasury bonds.
2. They have paid a dividend since 1948
3. They have increased their dividend for nine consecutive years, which means they did not cut their dividend during the recent recession.
4. Dividends have grown at just over 4% per year over the last 5 years.
5. They have a balanced electric power generating capacity with plants that use gas, coal, nuclear, and a small amount of alternative power production.
6. Most importantly, they are well managed and serve a growing area.

Southern Company and many other high quality electric, gas, and telephone utilities offer good dividend yields, solid balance sheets, and modest growth prospects.  As investors come to grips with just how low interest rates are, we believe they will increasingly move to investments that offer higher yields.  We think the first place they will look is the utility sector and Southern is our top pick.

We own Southern Company and have no plans to sell it.

The Market is Wrong About United Technologies -- And A Lot of Other Companies

Our Dividend Valuation Model suggests that United Technologies (UTX) may be as much as 17% undervalued.  The chart at the left shows this undervalued condition in the price (red line) being much lower than the current value (blue bars).

Additionally, the models suggests that UTX is undervalued nearly 30% (blue checkered bar) when we input our dividend and interest rate estimates for next year.  The chart shows that one would have to go back to 1998 to find UTX as undervalued as it is today.

Undervaluation is not a term that means much to speculators and traders in today's market.  Indeed, recent data from the CBOE puts the Correlation Index at nearly 80.  This means that the average stock in the S&P 500 is now nearly 80% correlated to the movement of the Index itself, thus discounting almost all individual company fundamentals.  According to Bloomberg, this is the highest Correlation Index since 1987.

So what does it all mean?  Worries about european defaults, political stalemate in Washington DC, and slowing US and european economic growth have turned almost all big US stocks into commodities.  Most are acting about like their underlying index.  Not only are the daily price movements of United Technologies (UTX) and Boeing (BA) highly correlated, as you might expect from companies in the same sector, but also the price movements of UTX, General Mills (GIS), and Walmart (WMT) are also moving together.  As the old timers would say, we now have a stock market instead of a market of stocks. 

You will note that the last time the Correlation Index was this high was during 1987 when all stocks shot higher for the first six months of the year, and then all fell like a rock over the last six months of the year.  They all went in the same direction, regardless of their diverse underlying prospects.

I said in 1987 that the stock market had lost its mind, and I still believe it.  I believe history will show that today's congealed group think will be proved just as wrong.

Companies like United Technologies have huge free cash flows, lots of cash, and firm orders for future business.  It would not surprise me to see UTX trading near our model's target price of $95 per share in the next 12 months.  Indeed, I think the odds of UTX rising 30% over the next year are much higher than the odds of it falling 30%.  The main reason is they are a financially strong, innovative, and decisively managed company.  They can handle whatever is thrown at them.  There are untold companies that are bouncing up and down just like UTX that cannot make the same claim.

We own UTX.