Tough year for dividends

10/13/2008


Early this year, Citigroup ($15; NYSE: C) faced an increasingly common dilemma.

The beleaguered financial-services giant could express confidence to investors by raising its annual dividend for the 21st consecutive year — or it could take steps to preserve its cash during a difficult environment. Citigroup chose to slash its dividend by 41% in January, then was forced to cut the reduced payout in half in September. Many companies face similar challenges.

For dividend investors, the September quarter was the worst in more than 18 years, as 138 U.S.-traded companies reduced or eliminated dividends, up from 21 in the year-earlier period. Many industry giants that have historically increased their payout each year are either standing pat or cutting back. Fifth Third Bancorp ($11; NASDAQ: FITB), KeyCorp ($10; NYSE: KEY), and Regions Financial ($11; NYSE: RF) abandoned records of growth extending more than 25 consecutive years to trim dividends this year. Meanwhile, the number of companies that increased dividends in the September quarter dropped 26% from the year-earlier period, following a 21% decline in the June quarter.

While the income stream from dividend-paying stocks appeals to many investors, many of the largest and best-known dividend stocks have performed poorly this year. Much of the blame can be traced to weakness in the financial sector, a favorite of income investors. The S&P 500 Financial Sector Index has declined 45% this year, versus a 32% drop for the broader index, with stocks of all types caught in the credit crunch. Of the 38 dividend cuts or suspensions from S&P 500 components this year, 33 were made by financials.

While dividend-paying stocks have had trouble in recent months, you should not be too quick to give up on your dividend stocks. A 2003 study of stock returns from 1970 through 2000 suggests that dividend-paying stocks tend to outperform nonpayers by 1% or more per month during market downturns, although that has not been the case during the recent slump. Over long periods of time, dividends should provide less-volatile returns and offer some downside protection in difficult markets.

So, where should stock investors seek income? Our advice is to look beyond yield and target stocks with solid dividend growth. While the financial, telecommunications, and utility sectors offer the highest current yields, our research shows that the highest-yielding stocks have delivered unimpressive returns in recent years.

The sectors with the best dividend growth over the last three years are energy and technology, though the financial sector has paced growth over the last 10 years. Five stocks with solid dividend growth are reviewed in the following paragraphs.

Aflac’s ($47; NYSE: AFL) Japanese sales, which represent 70% of revenue, have not been strong this year. But there’s still a lot to like about this insurer. Aflac says its 2008 target of 3% to 7% sales growth in Japan is “still achievable.” Revenue from medical-related insurance in Japan rose 9% in the June quarter. By the end of June, 154 Japanese banks had agreed to sell Aflac’s cancer and medical insurance at their branches.

The company’s focus on inexpensive supplemental coverage has limited exposure to many of the financial problems plaguing other insurers. Over the last year, Aflac shares have fallen 19%, versus a 56% decline for the S&P 1500 Insurance Group Index. In addition, Aflac’s highly recognized Japanese brand stands to benefit from the expected sell-off of the assets of American International Group ($4; NYSE: AIG), possibly including its large insurance business in Japan.

Aflac has grown quarterly dividends in each of the past 26 years, most recently a 17% hike in March. Over the last 10 years, dividends have increased at a 23% clip. Aflac, yielding 2.1%, is a Long-Term Buy.


Few companies enjoy a reputation for growing dividends like Johnson & Johnson ($62; NYSE: JNJ), which has increased its payout in each of the past 46 years. In April, J&J boosted the quarterly dividend 11%. The company pays out less than 50% of its earnings in dividends, allowing substantial operating flexibility, yet delivers a solid 2.9% yield.

Big dividend payments haven’t stopped J&J from investing heavily in research and development. Over the last 10 years, J&J has spent about 12% of its sales on R&D. The company boasts a deep pipeline of drugs under development. The psoriasis drug Ustekinumab and treatments for psychosis and infections should begin boosting revenue over the next year, helping to offset the effects of patent expirations for existing drugs.

In September, a study found that anemia patients taking high doses of J&J’s Eprex had a higher death rate than those taking a placebo, though the underlying cause of death has yet to be determined. While the health risks of anemia drugs are worrisome and could eventually crimp revenue growth, J&J’s diverse mix of pharmaceuticals, medical products, and consumer products seems likely to keep profits rising at a steady pace. Johnson & Johnson, trading at less than 14 times projected year-ahead earnings, is a Buy and a Long-Term Buy.


Qualcomm ($39; NASDAQ: QCOM) may provide some shelter in a slumping domestic economy. The telecommunications-equipment maker generates more than 70% of its revenue from manufacturers in South Korea, China, and Japan. South Korea, home to many makers of wireless devices, represents Qualcomm’s strongest source of growth.

To seize growth opportunities in wireless data and mobile broadband services on the Pacific Rim, Qualcomm is preparing to launch a bevy of new products, including third-generation wireless components and faster, more versatile microchips for laptops and communication devices. Expansion into laptops and mobile devices should help offset concerns that growth in the market for traditional mobile-phone handsets may slow. Hoping to build on its revenue base in Asia, Qualcomm is pursuing new wireless customers in China and India.

Qualcomm began paying quarterly dividends in 2003 and has increased the payout at an annualized rate of 45% since then. The company’s yield of 1.6% dwarfs that of most technology companies and represents an appealing kicker for a stock that also offers superior capital-gains potential. Qualcomm is a Focus List Buy and a Long-Term Buy.


Sigma-Aldrich ($45; NASDAQ: SIAL) is producing thousands of antibodies each year, with the goal of recreating all 22,000 unique human proteins by 2015. The company’s current library of 3,800 antibodies is available to researchers, as are 100,000 other chemical products used in research or manufacturing. Demand for Sigma’s research chemicals is not particularly cyclical, limiting the company’s exposure to slowing economies in the U.S. and Europe. In addition, much of Sigma’s business comes from high-growth overseas markets. To accommodate its overseas expansion,

Sigma has invested heavily in production and distribution networks. Sigma has increased earnings per share in each of the past five years, a trend likely to continue. Consensus estimates project per-share-profit growth of 14% this year and 11% next year, manageable targets for the specialty-chemical maker. Sigma pays out a modest 21% of its profits to investors and has grown its dividend at a 14% annualized rate over the last 10 years. Sigma-Aldrich is a Long-Term Buy.


With economic weakness squeezing small retailers, Wal-Mart Stores ($55; NYSE: WMT) is growing sales and taking market share. Many apparel and specialty retailers posted weak results in September, yet U.S. same-store sales rose 2.0% at traditional Wal-Mart discount stores and 4.6% at Sam’s Club wholesale stores. The retail giant’s strong results have not gone unnoticed. Wal-Mart shares are up 15% for the year, and the stock earns a Quadrix® Performance score of 91.

Retailers are bracing themselves for a rough winter. Many scientists are predicting harsh weather later in the year, but the chill has already reached consumers’ wallets, as food and energy command a bigger share of shoppers’ budgets. However, Wal-Mart’s large size and financial strength allow it to cut prices aggressively, capturing the business of shoppers trading down from upscale retailers. Anticipating weak spending during the all-important Christmas shopping season, Wal-Mart has cut prices for many popular toys, including Bakugan Battle Brawlers, a game predicted to be one of this year’s hot sellers. Christmas shops, designed to sell decorations and ornament gift packs, will open in stores by mid-October.

Wal-Mart has a history of sharing its success with stockholders, boosting the dividend at an annualized rate of 21% over the last 10 years. The company pays out about 28% of earnings in dividends. Wal-Mart Stores, yielding 1.7%, is a Long-Term Buy.

TOP DIVIDEND GROWERS
All of the 12 recommended stocks below have a dividend yield of at least 1% and have grown the payout at an annualized rate of at least 10%. Modest payout ratios suggest flexibility for future growth.
3-Yr. Annual.
—– Change —–
10-Yr. Annual.
—– Change —–
Company (Price; Ticker)
Dividend
($)
Yield
(%)
Payout
Ratio
(%)
Divs.
(%)
Per-
Share
Profits
(%)
Divs.
(%)
Per-
Share
Profits
(%)
Consecutive
Yrs. with
Higher
Dividend
Quadrix
Overall
Score
Sector
Advice
Aflac ($47; AFL)
0.96
2.1
27
29
14
23
16
26
89
Financials
LT Buy 
Airgas ($40; ARG)
0.48
1.2
17
29
30
NM
22
5
90
Materials
Focus Buy
General Dynamics
($65; GD)
1.40
2.2
24
18
23
12
16
11
92
Industrials
Buy †
IBM ($96; IBM)
2.00
2.1
25
32
19
16
10
13
82
Info. Technology
Focus Buy †
Johnson & Johnson
($62; JNJ)
1.84
2.9
42
13
10
14
13
46
83
Health Care
Buy †
MetLife ($37; MET)
0.74
2.0
12
17
7
20
19
6
60
Financials
LT Buy 
PepsiCo ($65; PEP)
1.70
2.6
48
18
13
12
10
36
75
Consumer Staples
Focus Buy †
Qualcomm
($39; QCOM)
0.64
1.6
30
25
16
NM
23
6
85
Info. Technology
Focus Buy †
Sigma-Aldrich
($45; SIAL)
0.52
1.2
21
11
16
14
12
18
67
Materials
LT Buy 
United Technologies
($50; UTX)
1.28
2.6
28
17
18
15
13
14
94
Industrials
Buy †
Walgreen
($27; WAG)
0.45
1.7
21
22
11
12
15
33
65
Consumer Staples
LT Buy 
Wal-Mart Stores
($55; WMT)
0.95
1.7
28
18
10
21
14
34
77
Consumer Staples
LT Buy 
Notes: Quadrix scores are percentile ranks, with 100 the best. The payout ratio represents the estimated year-ahead dividend divided by trailing earnings.      † Also qualifies as a Long-Term Buy.      NM Not meaningful.

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