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.