Dividends Beating Bond Yields by Most in 15 Years
More U.S. stocks are paying dividends that exceed bond yields than any time in at least 15 years as profits rise at the fastest pace in two decades.
Kraft Foods Inc. and DuPont Co. are among 68 companies in the Standard & Poor’s 500 Index with payouts that top the 3.80 percent average rate in credit markets, based on data since 1995 compiled by Bloomberg and Bank of America Corp. While Johnson & Johnson sold 10-year debt at a record low interest rate of 2.95 percent last month, shares of the world’s largest health products maker pay 3.68 percent.
The combination of record-low interest rates, potential profit growth of 36 percent this year and a slowing economy has forced investors into the relative value reversal. For John Carey of Pioneer Investment Management and Federated Investors Inc.’s Linda Duessel, whose firms oversee $566 billion, it means stocks are cheap after companies raised payouts by 6.8 percent in the second quarter, data compiled by Bloomberg show.
“That’s the tug-of-war that’s going on right now,” said Peter Vanderlee, a money manager at ClearBridge Advisors, a unit of Baltimore-based Legg Mason Inc., which oversees $659 billion. “If we are going into a double-dip recession, maybe we’re not as cheaply priced as one would suggest. The other side of it is that if we’re just experiencing a slowdown, but we’re avoiding a recession, then prices are clearly attractive.”
The last time the number of S&P 500 companies paying dividends above the corporate bond rate approached the current level was in March 2003, data compiled by Bloomberg show. That was just after the start of a bull market in which the equity index more than doubled over five years.
Bank of America Merrill Lynch’s U.S. Corporate Master Index has returned 9.5 percent this year, compared with the S&P 500’s gain of 0.4 percent, including dividends. Since 1995, bonds in the index have yielded an average of 6.2 percent, compared with S&P 500 dividends of 1.8 percent.
The relationship flipped after the Federal Reserve cut its target rate for overnight loans between banks close to zero and consumer prices fell by the most in six decades, helping send interest on 10-year Treasury notes as low as 2.42 percent last month. At the same time, U.S. economic growth forecast to reach 3 percent this year helped restore equity payouts after the most reductions ever in 2009, based on data tracked by Bloomberg.
Dividend yields were also helped by the 10 percent retreat in the S&P 500 since April 23. The drop pushed the price of the S&P 500 to 12.4 times estimated profits in the next year, near the lowest since March 2009. That’s giving investors a chance to buy stocks that pay more than bonds and offer more potential for price gains, Carey said in a telephone interview from Boston.
“It’s an attractive opportunity for people to get positioned in stocks that are paying good dividends and that are selling at relatively inexpensive price-to-earnings multiples,” he said. “That’s where the valuations are: in the big, blue- chip, dividend-paying stocks.”
Equities rose last week for the first time in a month as U.S. and Chinese manufacturing increased more than estimated and private employers added 67,000 jobs in August, beating the median estimate for 40,000 in a Bloomberg survey of 55 economists. The S&P 500 climbed 3.8 percent last week, and lost 1.2 percent to 1,091.84 at 4 p.m. New York time today.
Companies in the S&P 500, including more than 120 that offer no dividend, pay an average of 2.04 percent of their share price to shareholders, up from 1.8 percent in April, Bloomberg data show. U.S. corporate debt yields fell to 3.7 percent on Aug. 24, the lowest level in 20 years of information tracked by Barclays Plc. That day also marked the smallest spread between bond and dividend yields since at least 1995, according to data compiled by Bloomberg.
“It’s definitely a way to say that stocks are cheap relative to bonds,” said Barton Biggs, who runs New York-based hedge fund Traxis Partners LLC. The firm piled into equities at the bottom of the global bear market in March 2009, before the S&P 500 went on to gain as much as 80 percent, providing Traxis investors with 38 percent returns, three times the industry average, according to Chicago-based Hedge Fund Research Inc.
“You should own stocks rather than bonds,” Biggs said. “I don’t think bonds are the right things to be buying, particularly Treasury bonds.”
Concerns about the reinstatement of taxes on dividends and capital gains that were reduced under President George W. Bush may slow gains in utilities and telephone companies, the highest-yielding shares and the only groups among 10 that have risen since the S&P 500 reached its 2010 peak in April. Congress will begin debate this month on whether to extend the cuts. The 15 percent tax rate on dividends would jump to as much as 39.6 percent for the highest earners if the reductions expire.
“Anyone worried about navigating the next two quarters is probably justified in their concern” about the taxes, said Jack Ablin, chief investment officer at Chicago-based Harris Private Bank, which oversees $55 billion. “If investors are at least considering this worst-case scenario, stocks are more adequately priced based on more of the uncertainty related to stocks than bonds.”
J&J’s dividend represents 3.68 percent of its share price, or 1.12 percentage points higher than the yield on its bonds due in November 2019. The New Brunswick, New Jersey-based company, whose cash is 14 percent of total assets, posted higher-than- estimated profit on July 20. The shares have lost 8.9 percent this year.
“If you’re looking for current income, you look for some of these bigger companies that have nice dividend yields, where you could also possibly participate in the upside of this stock,” said Lon Erickson, who helps oversee $9 billion of fixed-income assets as managing director at Santa Fe, New Mexico-based Thornburg Investment Management.
Kraft, the world’s biggest confectioner, beat analysts’ profit estimates last quarter for the sixth straight time. The Northfield, Illinois-based company pays a quarterly dividend of 29 cents a share and yields 3.82 percent, 0.18 point higher than its bonds expiring in February 2018.
The shares have gained 12 percent this year to $30.35. Kraft increased its cash by 65 percent to $2.85 billion last quarter from a year earlier. The average S&P 500 company has $1.63 billion in cash, excluding financial firms, based on data compiled by Bloomberg.
DuPont Co., which has $3.96 billion in cash and near-term investments, pays 3.90 percent to shareholders, while bonds expiring in January 2020 yield 3.27 percent. The third-biggest U.S. chemical maker has surged 23 percent since the S&P 500 hit the 2010 low in July, compared with a 6.8 percent advance for the index, as second-quarter earnings surpassed estimates and the company raised its 2010 profit forecast because of improving global demand.
Shares of Wilmington, Delaware-based DuPont are cheaper than the equity index and the average of its peers, based on the price-earnings ratio of 12.7 using the past year of profit. That compares with 14.5 for the S&P 500 and 18.2 for the average of a group of commodity producers in the index. J&J is also cheaper than the S&P 500, trading at 12.4 times earnings, while Kraft is valued at 14.5.
J&J, Kraft and DuPont all have dividend coverage ratios, or earnings relative to payments, higher than 1. J&J’s is 2.3, while Kraft and DuPont have ratios of 1.76 and 1.17, respectively, data compiled by Bloomberg show.
S&P 500 companies’ cash probably has grown to a record for a seventh straight quarter, according to S&P. For companies that reported so far, balances increased to $824.8 billion in the period ended June 30 from the first three months of the year, based on data from the New York-based firm.
Cash represents 10.2 percent of total assets at S&P 500 companies, excluding banks and financial firms, according to data compiled by Bloomberg. That’s higher than the 9.5 percent at the end of the second quarter last year, 8.4 percent in 2008 and 7.95 percent in 2007.
“The economy is slowing down, but productivity has been so great in this country and companies have been able to make good profits,” said Duessel, the Pittsburgh-based equity market strategist at Federated. “Companies that would have cut their dividends already did so. It’s an unusual time where, yes, their profits are good, their cash is good, they can afford to pay more in dividends.”
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