It wasn't long ago that investors turned up their noses at dividends. In the go-go years of the late 1990s or mid-2000s, dividends were for fuddy-duddies. Companies increased shareholder value through growth, not returning cash.
Then, the world changed. The Bush-era tax cuts of 2003 gave more favorable tax treatment to dividends - just 15% versus the top rate of 35%. Also, interest rates continued to plummet, nudging investors to look beyond bonds for yield. Now tech giants are in the mix, too. Microsoft started the trend in 2003 and Oracle, Cisco, Intel and now Apple have joined in.
Investors are clamoring for dividends in the quest for yield. With the S&P High Yield Dividend Aristocrats index approaching an all-time high, some wonder if there's a bubble for dividend stocks.
DIVIDEND BY DIVIDEND
Shearer takes a more measured approach to dividend-paying stocks than investors do. That shows in the fund's long-term results. Over the three-year period that ended Aug. 1, the fund returned 13.2%, compared with 11.3% for the average peer in the large-value category where BlackRock Equity Dividend resides, according to Morningstar. That showing placed the offering in the top 19% of similar funds. Over the past five years, the fund posted a 2.1% gain, landing in the category's top 9%.
It's not enough for a stock to pay a dividend, though each of the 109 holdings does. Shearer wants companies whose dividends are both sustainable and growing, believing that that's one way investors can keep ahead of inflation. Shearer estimates the 10-year growth rate of the dividends in the portfolio is 11.5%, compared with 6.5% for the S&P 500 and 4.5% for the Russell 1000 Value, the fund's benchmark.
Shearer points to one long-term holding, IBM. In the late 1990s, its quarterly yield was just 12 cents a share. Since then, the tech blue chip has consistently raised its dividend. After a 13% increase in April, IBM now pays 85 cents a share. The stock is up 9.7% in the 12 months ending Aug. 1.
A study by C. Thomas Howard, a finance professor at the University of Denver shows that for every percentage point a company raises its dividend, its annual return rises by 0.22 percentage points if it's a large-cap, 0.25 for mid-caps and 0.46 for small-caps. Howard found that dividend growers outperformed dividend cutters by 10 percentage points a year from 1973 to 2010. They also trounced those stocks that didn't raise their dividends and non-payers, as well.
GETTING THE GROWTH
"To get dividend growth, you need to have earnings growth as well," he says. "We do a lot of work to find sectors that come into supply-demand imbalance."
Consider BHP Billiton, the Australian diversified miner active in aluminum, copper and coal. The firm's recent results have been off due to a slowdown in emerging markets and the European debt crisis. However, once Europe's fiscal situation is resolved and growth resumes in the U.S., BHP Billiton can stand to benefit, Shearer says. "There are limits to how much capacity there is for raw materials," he says.
BHP Billiton, which yields 3.3%, meanwhile, is down 24.7% in the 12 months ended Aug. 1.
In finding companies for the fund, Shearer applies a value investor's attention to balance sheet strength. Value qualities and dividends go hand in hand. To find companies for the portfolio, Shearer starts by looking at large-cap names that are trading at a discount to their five-year price-to-earnings ratio or at a discount to their peers. In addition, Shearer looks for companies whose debt equals less than 50% of their book capitalization. And the company should be a low-cost provider.
"These companies tend to hold up better when we do get into rough patches," he says.
Two names in the industrials sector fit the bill: Caterpillar as well as the aforementioned BHP Billiton. Both companies play to Shearer's focus on firms selling into the emerging markets, amd BHP Billiton keeps its costs among the lowest in the mining industry, Shearer explains.
Caterpillar has a yield of 2.3% and is down 16% over the last year. "They've seen their backlog grow over the last year," he says. "We think these companies are really going to benefit as we get more emerging markets people moving into the middle class."