Dividends: Mapping the Journey to Normal Files/Josh...DJDVY = Dow Jones U.S. Select Dividend Index...
Transcript of Dividends: Mapping the Journey to Normal Files/Josh...DJDVY = Dow Jones U.S. Select Dividend Index...
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© 2014 Morningstar, Inc. All rights reserved.
Dividends: Mapping the Journey to Normal
► Josh Peters, CFADirector of Equity-Income StrategyEditor, Morningstar DividendInvestor
About Morningstar DividendInvestor
►Launched in January 2005
►Josh Peters, CFA is Morningstar’s director of equity-income strategy, founding editor of DividendInvestor, and manager of its model portfolios
►Released companion book in 2008: The Ultimate Dividend Playbook
►Received over 1,100 dividends thus far from our recommended holdings—all of which reflect actual, trades in real money, Morningstar-funded brokerage accounts
Overview: Thinking About a “Normal” Equity Market
►What’s probably normal?►Low economic growth►Low inflation (excluding financial asset values, of course ...)►High profit margins and cash generation
►What’s not normal?►Interest rates (much too low)►Dividend payout ratios (also too low)
►Who are dividends for?►Everyone with an interest in risk-adjusted total return!
Primary Headwind: Rising Interest Rates
Monthly Data through Oct. 31, 2014. DJDVY = Dow Jones U.S. Select Dividend Index of high-yielding common stocks. MLPs = Alerian MLP Index. *No data available for 1993-94 cycle. REITs = FTSE NAREIT Equity REIT Index. All others are S&P 500 sectors. Sources: Morningstar, S&P, St. Louis Federal Reserve Bank
0%
2%
4%
6%
8%
10%
12%
14%
16%
1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016
10-Year Treasury Yields
HistoricalFuture Planning Assumption
S&P 500 DJDVY Staples Utilities Telecoms MLPs* REITsAverage Rate Cycle, 1993-2011Absolute Performance 18.6% 10.5% 11.3% 2.8% 10.7% 20.9% 12.3%Relative Performance -8.1% -7.3% -15.8% -7.9% -0.4% -6.3%
Rate Cycle, 7/2012 - 9/2013Absolute Performance 38.3% 31.6% 25.2% 6.7% 6.2% 27.7% 3.3%Relative Performance -6.8% -13.2% -31.7% -32.1% -10.6% -35.1%
Tailwind: Dividend Payout Ratios
Monthly Data through Oct. 31, 2014. Source: Morningstar, Standard & Poor’s, Robert Shiller (http://www.econ.yale.edu/~shiller/data.htm)
►Median payout ratio, 1946-1994: 53% Current payout ratio: 35%
►~50% upside for total dividend payments based on mean reversion
0%
16%
32%
48%
64%
80%
1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016
S&P 500 Index: Dividend Payout Ratio
Historical3-Yr AverageFuture Planning Assumption
0%
5%
10%
15%
20%
25%
30%
35%
1945 1955 1965 1975 1985 1995 2005 2015 2025 2035 2045
U.S. Population: Peak Savers vs. Retirees
Aged 35-54Aged 65+
Projected
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1945 1955 1965 1975 1985 1995 2005 2015 2025 2035 2045
Ratio of Peak Savers to Retirees
Projected
Tailwind: Demographics
►The U.S. investor base is aging, which all but guarantees anincreased preference for income and reduced tolerance for risk
Source: Moody’s Economy.com via FreeLunch.com, U.S. Census Bureau, Morningstar analysis
Tailwind: Scarcity
7
Data shows percent of S&P 500 market value in categories shown above as of Nov. 11, 2014. Source: Morningstar
Tailwind: Long-Term Outperformance
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
1937 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
High-Yield Equity Outperformance: 10-Year Rolling Total Returns
Advantage High vs. Low (average 2.7pp/yr)
Advantage High vs. Market (average 2.1pp/yr)
Annual Data 1927-2013. Source: Kenneth R. French, http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
Our Evaluation Process
►Current dividend yields generally 3% or higher►Willing to pay fair prices—not a traditional “value” strategy
►Economic moats: narrow or wide►Protects dividend income from the effects of competition►Encourages dividend growth as retained earnings are
deployed at high returns within the company’s moat
►Strong finances►Manageable leverage, healthy payout ratios, durable profits
►Management devotion to dividends►No arbitrary test of time, but clear commitment to growth
-50
0
50
100
150
200
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Cumulative Total Return: DividendInvestor Portfolios vs. S&P 500
Standard & Poor's 500 (CAGR: 7.8%)
Combined DividendInvestor Portfolios (CAGR: 9.5%)
-40
-20
0
20
40
60
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Cumulative Price Appreciation
S&P 500
DividendInvestor-40
-20
0
20
40
60
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Cumulative Dividend Return
S&P 500
DividendInvestor
Our Results: Income Leads to Outperformance
12.0 percentage point disadvantage (-1.3%/year)
31.4 percentage point advantage (2.8%/yr)
Data from inception (Jan. 7, 2005) through Oct. 31, 2014. Source: Morningstar.
Our Best Ideas Today (yields as of Nov. 12)
►Chevron (CVX; 3.6% yield)►Heavy spending will pivot to rising output and free cash flow
►General Electric (GE; 3.3% yield)►Rapidly repositioning toward infrastructure, away from GECS
►General Mills (GIS; 3.2% yield)►Long-term advantages intact through industry slowdown
►Magellan Midstream Partners MMP (MMP; 3.1% yield)►Highly attractive assets, great management & balance sheet
►Philip Morris International (PM; 4.6% yield)►Uniquely suited to provide high income and high growth
Summary
►Rising interest rates will be a headwind, though mainly in terms of relative performance
►Payout ratios have a lot of room to rise, but already-generous companies are still the best picks for long-term income generation
►Demographic tailwinds and scarcity of high-payout, low-risk businesses suggests continued outperformance over long time horizons
►Among individual dividend payers, seek economic moats, strong finances, dedicated management teams, and reasonable valuations
►Questions?
Disclosure: Josh Peters owns the following stocks in his personal portfolio: AEP, APU, CLX, CVX, EMR, GE, GIS, GSK, HCN, JNJ, KO, KRFT, MCD, MMP, NGG, O, PAYX, PEG, PG, PM, RCI, RDS.B, SE, SEP, SO, UL, UPS, WFC, XEL.