INSIGHTS

On September 21, 2011

Dividends: Paid To Wait and Poised to Rally

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There are myriad clichés that capital market participants and commentators (including us) like to call on from time-to-time to help soothe the pain or illustrate the potential for gain. One that we believe applies on almost any given day concerning dividend paying stocks is, “paid to wait.” However, there are certain times, like now, when we think we can add the addendum, “and poised to rally.”

We have been discussing for quite some time, both in our writings and speaking engagements, that we thought the U.S. equity markets were attractive based on current valuations and earnings growth (both current and projected), and that is still the case. The S&P 500’s current P/E (price to earnings) ratio sits at 13.15, which is well below its long-term average. Its year-over-year actual earnings growth sits at 16.24%, which is well above its long-term average, and its year-over-year earnings are projected to grow by 17.96%. In addition, the S&P 500’s current yield of 2.17% is now above the 1.92% yield of the U.S. 10-year obligation which we believe is going to embolden a lot of income-focused investors to begin to up their equity exposure.

It should also be noted that the S&P 500’s yield of 2.17% understates the opportunity as the index includes stocks that don’t currently pay a dividend. If we take an equal-weighted look at only the dividend paying securities in the index, we see the average yield is 2.53%. In addition, there are 134 members (26.8%) in the index currently yielding over 3% and 57 members (11.4%) in the index currently yielding over 4%. Whenever we discuss stocks with attractive yields we usually hear a few grumblings that these securities are accidental high yielders or value traps. That is the case with some of them and that is why investors need to do their homework when picking dividend stocks (or any investment for that matter). However, we do show there are currently over 30 stocks in the S&P 500 that not only are yielding over 3%, but have also grown their dividend at least 10% year-over-year as well as their earnings 10% year-over-year. Thus there are many stocks offering the potential for quality growth as well as an attractive income stream.

Add it all up and we think the trifecta of valuation, growth and dividend yield make U.S. stocks very attractive for long-term investors. Yes, there are many hurdles out there including European sovereign debt issues and a muted global economic outlook. However, it should be noted that the International Monetary Fund (IMF) just updated their global economic growth forecasts and still see the world economy expanding by 4% in both 2011 and 2012. Though disappointing to some, we still think that growth is sufficient to push the prices and dividends higher for a well chosen basket of securities. Dividends have historically provided a large portion of the total return of the equities market and over the last twenty years (8/31/91 – 8/31/11) that portion has been 42%. In addition, as illustrated above, investors can enjoy the potential for growth of both earnings and dividends while they patiently collect their current dividend, or as the old saying goes, paid to wait and poised to rally.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com.