Tuesday, January 11, 2011

Desperately Seeking Dividend Yield

Morningstar Dividend Investor
Desperately Seeking Dividend Yield: Why Capital Gains Aren't Enough

By Josh Peters of Morningstar Investment Research


Investors Cannot Live on Capital Gains Alone: Investment Challenges In a Low-Return World

Some have termed the last 10 years a "lost decade" for stocks, as the typical American investor has been rewarded with temporary gains at best and permanent losses at worst. Volatility, uncertainty, and disappointment have kept millions of investors from reaching their goals.

I am not about to give up. Having worked hard and saved, I'm determined to hang on to the fruits of my labor and increase its value over time. But no longer do I fight this battle on Wall Street's terms.

Over five years ago, I charted a new course:

1. I focus on income instead of capital gains.

2. I approach stocks as a potential owner and partner in a business, rather than as a trader.

3. I insist that any business I partner with must treat me fairly.

The factor common to these three goals is simple: dividends. Not just any dividends, but large, reliable, and growing streams of cash that I never need to give back. These are what I am determined to provide in the pages, website, and e-mails of Morningstar Dividend Investor.

Many explanations are being offered as to why stocks have had such a poor run so far this century. I say, "Follow the money." The sad fact is that most American corporations no longer recognize or treat shareholders as true owners. Even as the economy struggles to climb out of the worst recession in more than 70 years, profits are soaring. Yet the bulk of these earnings, as in the decade just past, aren't finding their way to investors. Instead, these rivers of cash are diverted toward empire-building acquisitions, dubious share repurchases, and obscene executive pay packets.

This has led to an environment where, no matter how interest rates seem to go, stocks still can't compete. Total profits for the companies that make up the Standard & Poor's 500 index could top $900 billion in he upcoming year, yet their dividend payments are running at only $211 billion--less than 25 cents on the dollar! The average stock in this group yields only 2%, half of the historic average of 4%.

When I set out to seek better results, I had to let go of the idea that a stock is a piece of paper to be traded back and forth. Frankly, as manager of Morningstar Dividend Investor's two model portfolios, I engage in relatively few buys and sells. Instead, I've taken on the mantle of the great capitalists of old: Those who sought out good businesses, invested their money only on attractive terms, demanded a fair share of the profits, and let their capital do the work.

This approach will not work with just any old stock. Above all, such a strategy requires a large dividend yield (no less than 3%, in my opinion, and preferably between 4% and 7%) to provide a reasonable prospect of success. Where you find large, reliable, and growing dividends, you're probably looking at an enterprise that is consistently profitable, relatively unburdened by debt, and whose management runs against the tide to treat shareholders like actual partners.

What are some of these stocks I've bought and recommended to Morningstar Dividend Investor subscribers? One calls itself "the monthly dividend company" and has raised its dividend in each of the last 50 calendar quarters. Another dominates one of the most humdrum fields imaginable: the distribution of propane gas. Still another has dodged the health-care industry's enormous challenges to raise its dividend at a double-digit pace while many of its rivals struggled just to keep their dividends flat.

The truth is that dividends are more than just pocket change, more even than a basis for a comfortable retirement. Dividends are the sole and essential link between investors and the businesses they own. Day by day and month by month, I comb through the market for extraordinary businesses. I put each and every candidate through a rigorous set of tests focused on their dividends. Those that pass become part of our model portfolios, each of which demonstrates returns with real-money transactions, not paper-based claims.

Investment success in the decade to come will not come easy or by accident. Losing the last decade was a dreadful shame. Losing another is simply not an acceptable outcome. To stand out, I believe an investor will need unique perspectives on the markets, an unusual amount of discipline, a willingness to shed Wall Street's hot-money mentality, and, above all, an insistence on being rewarded as a stock's rightful owner through attractive and rising cash dividend payments.

Click here for a free trial of Morningstar Dividend Investor.

Click here for the Morningstar SmartInvestor update every weekend.