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Where To Turn As Dividend Yields Fall

Even with dividend yields falling over the past few years as the stock market continued to rise, the growth of dividends over that time frame has more than offset the declining yield.

While S&P 500 dividend payments continue to set records, the pace of growth has decelerated, as fears of a global slowdown keep executives from pumping up shareholder returns. The average dividend has increased 13.5 per cent for S&P 500 companies so far in 2015, compared with a 17.3 per cent rise a year earlier, according to S&P Dow Jones Indices.

Cash payouts, as well as stock buybacks, have come under threat from concerns over economic growth and lackluster earnings forecasts. "We're not seeing many of the dividend increases we'd see in the past," Jack Ablin, chief investment officer of BMO Private Bank, said. "Part of it was companies hoarding cash."

In recent years, yield-starved investors have sought shares that pay hefty dividends, a point of attraction for stocks such as Wal-Mart (WMT) and Exxon (XOM). The appeal of dividends remains strong, particularly as Wall Street economists and strategists are cutting their forecasts for where the benchmark 10-year Treasury will end the year.

So-called dividend aristocrats, companies within the S&P 500 that have consistently raised dividends each year for the last 25 years, have also found a renewed bid. The total return from the group is roughly flat since the second half began, in contrast to a 1.8 per cent decline by the S&P 500.

Companies are loath to cut dividends, a signal that the board of directors and management see the long-term earnings power diminishing. However, companies can only pay out what they have. That's why we need to also look at a company's payout ratio, defined as the percentage of net income that a company pays out as dividends to common shareholders. A payout ratio of 10% means for every dollar in Net Income, 10% is being paid out as a dividend. If the payout ratio approaches 100% then the days of solid dividend growth could be over for those companies.

Today I want to look at two companies that have a history of raising dividends (even in recessions) and have a payout ratio below 60%. These two companies are Exxon (XOM) and Johnson & Johnson (JNJ).

Dividend Yield

Five Year Annualized
Div. Growth Rate

Payout Ratio

Exxon

3.5%

10.2%

49%

Johnson & Johnson

3.0%

7.4%

50%

These are two of my favorite dividend-growth stocks. They have a nice dividend yield of at least 3%, their payout ratios are low, and their dividend growth rates over the past five years are both solid. Also, in the market downturn of 2008 and 2009 they continued to increase their dividends.

 

The great thing about these companies having such low payout ratios is that they can still continue to increase their dividends (or at least not cut them) if times get tough. They have a lot of room for error. I ran a couple of scenarios in our dividend calculator named Dividend Yield & Growth and found that even if the dividend growth rates are cut by half over the next 20 years we will see the following:

Compounded Return From
Dividends Only

Annualized Return

Exxon

196%

5.6%

Johnson & Johnson

121%

4.0%

These are pretty impressive numbers given that we cut their dividend growth in half and applied no growth in their stock price.

In terms of investing in these types of companies for retirement, I have found by plugging in various dividend yields into our Retirement Planner that finding dividend payers who can return just 2% more than bonds or other dividend payers can increase the time that funds last in retirement by more than a decade. The key is finding companies who will either pay a strong dividend or have serious dividend growth and have shown a culture of not cutting dividends when times get tough.

It is important to look at many variables when investing for future dividends. Sometimes the payout ratio is overlooked and investors are caught by surprise when dividend growth comes to a halt for some of their holdings.

 

 

 

 

 

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