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Comparing Dividend ETFs

I like ETFs as an investment vehicle.  And I love dividends as a source of investment return.

So, one might draw the conclusion that I was favorably disposed towards dividend ETFs, and indeed I am (see “Dividend ETFs for Growth and Income”).

Today, I’m going to take a look at one relatively new entrant in what has become a bit of a crowded fields: the iShares High Dividend Equity Fund ($HDV), which tracks the Morningstar Dividend Yield Focus Index.

To meet Morningstar’s criteria for index membership, companies must have a Morningstar Economic Moat rating of narrow or wide and have a Morningstar Distance to Default score in the top 50% of eligible dividend-paying companies.  The index is then composed of the top 75 companies by dividend yield that meet these criteria.

This requires a little explaining.  Warren Buffett has spoken often of preferring companies with economic “moats” around them that make a challenge from a would-be competitor a challenge.  Coca-Cola’s ($KO) unmistakable brand would be a good example, as would Microsoft’s ($MSFT) domination of the personal computer platform through its Windows operating system and Office productivity software. Not even mighty Apple ($AAPL) has been able to scale Microsoft’s moats in its core areas of expertise.

Morningstar has built upon this “moat” concept, defining it as “the sustainability of a company’s future economic profits.”  In order to earn a narrow or wide moat rating, a company must have “the prospect of earning above average returns on capital, and some competitive edge that prevents these returns from quickly eroding.” Obviously, there is a degree of subjectivity involved, as this is not a numeric value that can be found in a stock screener.  And to be sure, not all moats prove to be unassailable (consider that Research in Motion’s ($RIMM) enterprise email and messaging ecosystem might have been considered a moat just a few years ago). 

Morningstar’s Distance to Default Score is more quantitative yet also a little more esoteric.  It uses option pricing theory to evaluate the risk of a company becoming insolvent. 

While I like Morningstar’s focus on moats, I’m a little more skeptical on its distance to default metric.  Yes, the metric would probably do a decent job most of the time of preventing you from buying a high-yielding stock that was on the verge of slashing its dividend en route to going bust.  Yet option pricing theory would have done little to foresee an event like the 2008 meltdown until it was far too late, and it certainly didn’t prevent Long-Term Capital Management from blowing up a decade before.

HDV is a sibling to the older and better-known iShares Dow Jones Select Dividend ETF ($DVY), which I highlighted in the article I referenced above and which I use in my Covestor Strategic Growth Allocation.  DVY is the granddaddy of all dividend ETFs, and tends to be heavily weighted towards utilities (currently 31% of the ETF) and consumer staples (16%).

HDV holds a much smaller allocation to utilities (just 14%), but has large allocations to health care (29%) and consumer staples (24%).

According to iShares, both ETFs currently yield 3.6%, and both have expense ratios of 0.4%.  Over time, I would expect DVY to sport a higher current yield, though I would expect HDV to offer better potential for capital gains.  In the short-to-medium term, the decision of one over the other is essentially a matter of sector preference.

For longer-term capital gains, my preference remains the Vanguard Dividend Appreciation ETF ($VIG).  Though it currently yields no more than the broader S&P 500, the ETF is comprised of companies that have raised their dividends every year for the past 10 years.  And while there is no guarantee that they will continue to raise their dividends going forward, the 10-year criteria ensures that you own a portfolio of some of the highest-quality growth companies in the world.  The dividend criteria is also more objective than Morningstar’s moat rating, which depends on the judgment of Morningstar’s analysts.

With that said, any of the ETFs mentioned in this article could be considered as long-term holdings for investor portfolios.  But investors willing to do a little research on their own should eschew buying the ETFs and should instead use their holdings as a convenient stock screener.  Pick and choose the companies you like best from each.  Coca-Cola—which happens to be one of Warren Buffett’s all-time favorites—happens to be a holding of all three ETFs.

Disclosures: DVY, MSFT and VIG are held by Sizemore Capital clients. This article first appeared on MarketWatch.

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Philip Morris International: A Dividend Stock Best Avoided

Nothing is more detrimental to the long-term viability of an investment theme than its own success.  In the often circular logic that defines the market, profitable trades can only remain so as long as they are unpopular.  Once they are embraced by the investing public, prices have generally risen to a point that would make the trade unattractive to its original value-focused adherents.

It is thus with great sadness that I must recommend readers sell their shares of Philip Morris International (NYSE: $PM).  At current prices, this is a dividend stock best avoided.

When Altria (NYSE:$MO) spun off its international tobacco businesses and formed Philip Morris International in 2008, it was about as close as you could get to the perfect stock.  You had all of the standard bullish arguments for tobacco—recession-resistant demand, an addicted customer base, low marketing costs, high cash flows, etc.—but without the threat of crippling lawsuits from the U.S. tort system.

Philip Morris International was also uniquely positioned to take advantage of rising incomes in the developed world.  As consumers in key emerging markets such as China traded up from lower-quality domestic brands, the maker of Marlboro was uniquely positioned to benefit, and still is.

And finally—and perhaps most importantly—Philip Morris International was a dividend-producing powerhouse at a time when decent yields were hard to come by. 

It was the convergence of all of my favorite investment themes in one stock: a high-dividend sin stock with emerging market growth and brand cachet!

But no matter how great an investment looks, your long-term success is ultimately dependent on the price you pay.  And the reason that tobacco stocks have been such great wealth-creation vehicles in recent decades is because they have been perpetually priced as high-dividend value stocks (see “The Price of Sin”).

Let’s face it.  Tobacco is not a growth industry, not even in most emerging markets.  While smoking remains popular in many, market penetration hit the high-water mark a long time ago.  And as health awareness rises with incomes, the best the industry can hope for is gentle decline.

Knowing this, long-term investors tend to by tobacco stocks for one and only reason—the high dividends they offer.

Yet consider how Philip Morris International’s dividend stacks up with other consumer-oriented companies with large footprints in emerging markets.

Company

Ticker

Dividend Yield

Forward P/E

Johnson & Johnson

JNJ

3.7%

12.1

Philip Morris International

PM

3.6%

14.8

Procter & Gamble

PG

3.8%

15.1

Unilever

UL

3.9%

13.7

 At current prices, investors can get a higher dividend yield in Johnson & Johnson (NYSE:$JNJ), Procter & Gamble (NYSE:$PG) and Unilever (NYSE:$UL), and Philip Morris International trades at a higher P/E ratio than all but Procter & Gamble.  And while each of these three examples has had its share of problems in recent years, the longer-term prospects for all are vastly superior to those for Philip Morris International.

Let me put it to you like this: 50 years from now, I suspect that Philip Morris International will still be selling plenty of cigarettes.  But I’m betting that Johnson & Johnson, Procter & Gamble, and Unilever are selling a lot more Band-Aids, razor blades, and shower gel, respectively.  I’m grossly oversimplifying the businesses of all three of these companies, but my point stands: Philip Morris International is only attractive if it is priced at a significant discount to mainstream consumer products companies like the ones mentioned in this article.

This condition does not hold today, which is why I must regrettably make Philip Morris International a “sell.” 

Investors looking for income these days still have plenty of decent options, even if reliable choices from years past are no longer as attractive as they might been.  Many oil and gas master limited partnerships offer attractive yields, as do select specialty REITs.  Telecom and utilities stocks are also attractive.  But at current prices, investors might find Philip Morris International’s stock as dangerous as its products.

Disclosures: Sizemore Capital is long MO, PG, JNJ and UL

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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European Dividend Stocks: What You Need to Know

For all the talk of dividend investing in recent years, it’s easy to lose sight of the fact that the average U.S. stock, as measured by the S&P 500, still yields a paltry 1.9%.

Even the Vanguard Dividend Appreciation ETF (NYSE: $VIG), a core long-term holding in my ETF portfolios—barely yields 2%, and this is a dividend-focused product.   

In a world where the 10-year Treasury note yields an almost laughable 1.5%, the dividends onU.S.stocks might seem downright rich in comparison.  But for an investor looking to fund their retirement through portfolio income, they still don’t pay the bills. 
Not surprisingly, many investors have gravitated to higher-yielding European stocks.  The dividend yield on large-cap European stocks is more than double that of their U.S. counterparts; as a case in point, the Vanguard MSCI Europe ETF (NYSE:$VGK) yields 4.3%, compared to the 1.9% offered by the SPDR S&P 500 ETF (NYSE:$SPY).

The PowerShares International Dividend Achievers ETF (NYSE: $PID), which like VIG, focuses on dividend growth rather than high current yield, also pays out significantly more than its U.S. counterpart, at 3.1% vs. 2.0%.

Still, those higher yields have offered little protection to investors who have seen their “safe” dividend paying stocks lose 20% of their value in a matter of weeks.   I see a lot of value inEuropeat current prices, and I believe the ongoing sovereign debt crisis has created opportunities for those of us willing to take the risk of a little short-term volatility.  But given that the months ahead promise to be a rocky road, it’s important that investors understand a few things about European dividend stocks.

Here are a handful of points to keep in mind.

  1. When looking at the dividend history, remember to take into account the effects of currency moves.  As a case in point, consider the Anglo-Dutch consumer products giant Unilever (NYSE: $UL).  Unilever has raised its dividend for over 25 consecutive years.  But if you look at the company’s dividend history on, say, Yahoo Finance, you’ll see that the dividend paid by the U.S.-traded ADR appears to shrink in some years.  This is due to changes in currency exchange rates.  So, when doing your research, look for the dividend history in the reporting currency and take the posted dividend history of ADRs with a grain of salt. 
  2. European firms tend to make two payments per year.  For U.S. investors accustomed to regular quarterly payouts, the European tradition can be confusing and send conflicting signals.  There is generally a larger “final” dividend declared and paid after the fiscal year has finished and a smaller “interim” dividend roughly six months later.  Again, using Unilever as an example, you can see that this was the company’s policy prior to 2010. (Starting in 2010, Unilever adopted a policy more in line with American norms of paying a regular quarterly dividend; see the company’s statement for more info.)
  3. Rather than keep the dollar amount of the dividend stable, European firms have historically sought to maintain a stable payout ratio.  This means that the cash payout to investors can vary wildly based on the company’s performance in any given year.  While this makes sense from the company’s perspective and allows for more financial flexibility, it can be frustrating for investors who depend on the dividend to meet their current income needs.  As capital markets become more global and investors more vocal, European companies are slowly adopting the  practice of paying more regular dividends. 

One final point to consider when investing inEuropeis the maturity of the markets. Europeis a developed continent with an aging population.  With little need to invest for  growth in their home markets, European companies are, by and large, mature cash cows that throw off a lot of cash. 

In The Future for Investors, Jeremy Siegel pointed out that slow-growth companies (or even negative growth) companies can make fantastic investments, and he used tobacco giant Altria (NYSE:$MO) as an example.  By Professor Siegel’s calculations, Altria was the most profitable investment of the past century, despite the fact that tobacco has been a dying business since at least the 1970s.    With no need to invest in a non-existent future and being restricted from advertising, Altria had little else to do with its cash than to pay dividends. 

Though I would stop short of comparing the entire European stock market to Big Tobacco, the lessons are much the same.  A slow-growth, high-dividend portfolio can produce spectacular returns over time.

I’ve recommended PID as a “fishing pond” for solid European dividend stocks, and I would reiterate that recommendation today.  Consider buying the ETF or, if you’re up for the challenge of researching individual stocks, use the ETF’s underlying holdings as a screened list of high-quality dividend payers from which to choose. 

Disclosures: Sizemore Capital is long MO, PID, UL, and VIG

 

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Which Dividend Payer Would You Choose?

In looking at two companies in the same sector, would you prefer to have a stock that pays a 2.7% dividend or one that pays a 3.1% dividend?

The answer might seem obvious at first; all else equal, who wouldn’t take the higher cash payout? But before you answer, take a look at Figure 1.

Figure 1


This chart shows the quarterly dividend of the two companies I mentioned above, both major U.S. retailers.  You will immediately notice that one company, “Company A,” has done a much better job than the other of raising its dividend over the past decade and particularly in the last few years.

Company A is the lower yielding of the two, with a current dividend yield of 2.7%.  But should it continue to raise its dividend in the years ahead, investors would realize a much higher cash payout over time despite the slightly lower yield today.

So, let me ask again, dear reader: Would you prefer to have a stock that pays a 2.7% dividend or one that pays a 3.1% dividend?

I’m sure you know what my answer is, and you probably agree.  You will probably agree even more when you find out what the two companies in question are: Company A is megaretailer Wal-Mart (NYSE:$WMT) and Company B is beleaguered electronics chain Best Buy (NYSE:$BBY).

In my last article, I warned investors not to “chase” high dividend yields.

You have chosen wisely.

And while I would hardly call buying a stock that yields 3.2% “chasing” a high yield, the core lesson is the same.  When building a solid, long-term income portfolio, you cannot make your investment decisions based on current yield alone.  Doing so puts you at multiple risks, all of which can be devastating to you long-term investment goals.

I’ll start with the obvious: business risk.  An exceptionally high current yield often means that investors have sold off the stock or bond due to real, fundamental problems with the business. It also often means that the market is discounting a cut to the dividend.

Does this mean that you should always avoid exceptionally high yielders?

Of course not.  Often times the market overreacts and gives us contrarian value investors fantastic opportunities to be greedy when others are fearful.  You have to look at each case individually and make a judgment call.  To give a recent example, I believe that the potential returns far outweigh the risks in Spanish telecom giant Telefonica (NYSE:$TEF), despite the risks implied by its 11% current yield.  There may be short-term turbulence in Europe, but the company’s long-term future is very bright.

I would be far less enthusiastic about, say, Teekay Tankers (NYSE:$TNK), which yields 9.8%.  The oil tanker business is extremely cyclical and subject to booms and busts.  And given the cut-throat competitiveness of the business, longer-term dividend growth (or even dividend maintenance) is by no means certain.

The second reason to focus on dividend growth is protection from the ravages of inflation.  I have no doubt in my mind that Wal-Mart will continue to prosper. Most of what it sells is merchandise that consumers are unlikely to buy online due to convenience and timing issues.  (On a personal note, most of my Wal-Mart purchases are spontaneous and based on immediate needs.  Where else do you buy a Rubbermaid trashcan, a can of paint, or a case of Dr. Pepper at 3:00 am?)

Wal-Mart’s dividend should easily beat inflation in the years ahead, which is critical for retirees that depend on dividends to meet their current living expenses.

I can’t say the same for Best Buy.  While the company is the last man standing among major big-box electronics chains, it is getting hit from two sides.  Shoppers tend to use the stores as a showroom to try out new electronics before whipping out their smartphones to order them online for far cheaper.  And for larger items no usually purchased online—such as home appliances—Best Buy will continue to see tepid growth for as long as the housing market remains depressed.

Best Buy would not appear to be at risk of failure in the immediate future, but investors searching for steady dividend growth should look elsewhere.

Disclosures: WMT and TEF are holdings in the Sizemore Capital Dividend Growth Portfolio.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Beware of Chasing High Dividend Yields

What’s the easiest way to find a stock with a 10% dividend yield?

Find a stock yielding 5% and watch its price get cut in half.

I say this mostly in jest, but this is precisely what happened to investors in RadioShack (NYSE:$RSH), the iconic electronics and gadgets chain still found in most American shopping malls.  At time of writing, RadioShack yields 9.8%, and this is after the company already slashed its dividend.

Given that it is paying out substantially more than it earns, RadioShack will almost certainly further reduce or eliminate its dividend in the coming quarters.  The company barely earns a profit, and it faces a war of attrition it can’t win against larger “big box” rivals like Best Buy (NYSE:$BBY) and Wal-Mart (NYSE:$WMT) and from internet retailers like Amazon (Nasdaq:$AMZN).

In a race with no winners, it will be interesting to watch what falls faster, RadioShack’s price or its dividend.

I’ll quit beating up on RadioShack.  In fact, I wouldn’t be surprised to see the company enjoy a nice rally in the months ahead.  No one can argue that RadioShack is not cheap; the stock trades for 0.67 time book value and a shocking 0.11 times sales.  Almost incredibly the stock currently sells for less than the value of its cash in the bank, $4.97 vs. $5.70.  (Before you value investors start licking your chops, keep in mind that RadioShack has substantial debts against that cash; as of year end, the company had $1.4 billion in debts vs. a little under a billion in cash and receivables.)

The stock could also benefit from a dead-cat bounce.  With the short interest in the stock currently more than seven times the average daily trading volume, it could benefit from a short-covering rally if nothing else.

But that is exactly how investors should view RadioShack—as a potential short-term trade and nothing more.  It should certainly not be considered a long-term income play, as that 9.8% yield can disappear overnight.

This brings me to the point of this article: an investor should never chase a high dividend yield.

Exceptionally high dividend yields generally mean one of two things:

  1. The dividend is expected to be the only source of return, and investors should not anticipate much in the way of capital gains.
  2. The dividend is at serious risk of getting cut and the market has already priced the stock accordingly.

The first category is not all bad, so long as investors understand this going into the trade.  Many popular investments such as mortgage REITS would fall under this category.  Annaly Capital (NYSE:$NLY) and Chimera Investment Corp (NY6SE:$CIM) both currently yield in excess of 13%.  The dividends are by no means stable, however, and the payout will almost certainly fall when the Fed eventually raises rates.

Tobacco companies have enjoyed phenomenal returns of late and have been the Sizemore Investment Letter’s best-performing investment theme over the past year (see “Tobacco Stocks Still Smokin’”), but they too should be considered zero-capital-gains investments over the longer term. Investors can profit quite handsomely from the reinvestment of dividends and from share buybacks, but this is a sector in long-term terminal decline.

It is the second category where investors tend to get themselves in trouble, both in the stock investing and bond investing.  Alas, your humble correspondent was one of the hapless souls who bought shares of Thornburg Mortgage in 2008 because it had a yield of over 10% and a “solid” portfolio of super-prime jumbo mortgages.  That 10% yield didn’t get me very far when the company filed for bankruptcy. How many other investors were seduced by the 20-30% yields offered on General Motors bonds around that same time?  Again, we know how that worked out.

Investors can avoid these traps by setting reasonable expectations.  If a yield seems too high to be true, it probably is.  Roll up your sleeves, take a look at the company’s financials, and make that judgment call with a sober mind.

Income seekers currently have their pick of the litter of safe, moderately high-yielding stocks with room for dividend growth and price appreciation.  As an asset class, master limited partnerships are attractively priced, and several—including Williams Partners (NYSE:$WPZ) and Kinder Morgan Energy Partners (NYSE:$KMP)—yield over 5%.

REITS are more expensive as an asset class, buy here too there are bargains to be found.  National Retail Properties (NYSE:$NNN) and Realty Income Corp (NYSE:$O) yield 5.7% and 4.5%, respectively, and consider both to be safe.

Investors willing to accept modest risk of a temporary dividend cut should consider Spain’s Telefonica (NYSE:$TEF).  Telefonica currently yields over 10%, and its share price has taken a beating along with the rest of the Spanish stock market.  I consider a dividend cut to be unlikely, though the Board may opt to conserve cash if the European capital markets seize up again.  Still, any cut in this case would be temporary, and I expect the dividend to be substantially higher 3-5 years from now.  Unlike, say, RadioShack, Telefonica has a healthy business with excellent long-term prospects, particularly in Latin America.  Use any weakness as a buying opportunity.

Disclosures: KMP, NNN, O and TEF are all holdings of Sizemore Capital’s Dividend Growth Portfolio.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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