Friday, June 20, 2008

Dow Jones Dividend Watch: Good Readings

All of us have been fixated on the subprime crisis in banking and it many twists and turns, but the financials as a sector represent only 15%-20% of all stocks and banks are an even smaller percentage of that total.

Our dividend strategy states that long-term dividend growth is the key to price growth. Our work on the Dow Jones Industrials shows us that if you include changes in interest rates and earnings growth with dividend growth, the correlation with price reaches nearly 90%.

With bank dividends much in the news, and seemingly headed in the wrong direction, that must mean that our dividend strategy should be signalling that bad times are ahead.? Nothing could be further from the truth. Indeed, the table below shows that dividend growth is very much alive and well and signalling that dividend troubles in financial land are not spilling over into the other industry sectors, and by extension other parts of the economy.

Over the past 12 months, approximately the time of the blow up in the subprime crisis, the average dividend growth for the 30 stocks in the Dow Jones Industrials has been 10.4%, as shown in yellow at the bottom of the table. Let's put that in perspective. That is about the same dividend growth as the Dow has experienced over the last 5 years and nearly double that of its 50-year average of 5.7%.

Let's look at the dark side first. At the bottom we see Citigroup with a whopping 41% cut in its dividend over last year. It was the only stock in the Dow to cut it dividend, but there was another small group of companies that would not make it on any dividend stars list: Alcoa, Home Depot, Merck, JP Morgan Chase, and General Motors. They did not increase their dividends during the year.
Looking at the bright side, we see that McDonalds increased its dividend by 50%, while IBM, Intel, United Technologies, and American Express all increased their dividend by over 20%.

Wait a minute, isn't American Express a financial in that very risky business of credit cards? Surely the management of this company has lost its mind. Don't they know that every consumer in America is doomed to bankruptcy? That is what many gurus would have us believe. Surely that increase could not be recent. Perhaps it was in June of last year before things really began to fall apart. Nope, the increase was payable in November. AXP hiked their dividend 20% in the absolute eye of the subprime storm. You did not hear it because the "meat-eaters" (media) weren't looking for any good news to put on the table during that time.

Dividends growth was not a scarcity in the last 12 months for the Dow stocks, and we don't believe it will be over the next 12 months either. There will be a jockeying around for the growth leadership, and indeed, another company may cut its dividend during the coming year (GM is a near sure thing), but on balance the good news will win out over the bad news just like it has for the last 50 years. Only 7 times in the last 50 years have cumulative dividends fallen for the companies in the Dow.

In case you are wondering, our Dow Jones Valuation Model, in this case including dividends, earnings, and interest rates, is now projecting the current "fair value" for the Dow is just over 14,000. That seems like a long way off in light of the current troubles, but all of us know that sooner or later the troubles pass. The difference between today's 12,000 and our models "fair value" of 14,000 seems unattainable, and it is certainly not a guarantee that stocks will be much higher in the months to come. but it is just saying that stocks are very cheap today, when viewed statistically versus the past.

From our model's perspective, the only way that stocks are not cheap is if earnings and dividends fall sharply, and interest rates rise sharply. Small changes in any of the data would still leave us undervalued. Furthermore, weakness in financials alone could not put us in an overvalued position. Financials in the Dow are only about 13% of the value.

I realize this is more good news, and you may not be in the mood for good news, but this is the reality of what is going on in the "whole market", not just the financials.

From the sounds of the doom and gloomers, the darkness is circling all around us. Can the dawn be so far away, particularly when our valuation models are so undervalued.