In an environment of ultra-low interest rates and financial repression, companies that yield anything from 3 to 11%, particularly those that increase their payouts over time, are becoming increasingly attractive. This article examines the subject of dividends and presents the ultimate dividend paying portfolio.
For those that don’t have the time to research and track a dozen or more individual companies, the internationally recognized investment newsletter, Investment Quality Trends provides an excellent alternative. Established in 1966 the newsletter provides company data and analysis to its subscribers allowing them to construct a portfolio of large, high-quality dividend paying companies that have a solid record of profitability.
The tried and tested strategy behind Investment Quality Trends involves buying the top dividend paying stocks when their dividend yields are historically high, and selling them when their dividend yield declines to historic lows. In other words it is a type of value investing.
The founder of Investment Quality Trends, Geraldine Weiss, is quoted as saying:
“When all other factors which rate analytical consideration have been digested, the underlying value of dividends, which determines yield, will in the long run also determine price. The key to value, therefore, lies in yield as reflected by the dividend trend. Individual stock prices fluctuate between repetitive extremes of high dividend yield and low dividend yield. These recurring extremes of yield establish Undervalue and Overvalue price levels. When a dividend is raised, the Undervalue and Overvalue price levels are raised automatically so they will continue to reflect the historically established yield extremes. Each stock has its own distinctive high and low yield characteristics and must be evaluated individually.”
In January 2000 Investment Quality Trends began publishing “The Lucky 13”, which is a portfolio of stocks that offer historically good value. The portfolio is designed to emphasize sectors of the market that while perhaps are currently out of favor, nonetheless offer exemplary fundamentals and attractive dividend yields.
The Lucky 13 has produced ten years of positive total returns, and trough 2011 the arithmetic average annual return for the portfolio is 12.07%. The compound annual growth rate (CAGR) is 11.08%. For comparison purposes, the arithmetic average annual return for the S&P 500 is 2.37% and a CAGR of 0.46%.
Another possible approach might be to invest in Carl Icahn’s publicly traded master limited partnership (MLP), Icahn Enterprises L.P. (NASDAQ: IEP) which currently yields 5.85%.
The $6 billion MLP is a holding company which is engaged in nine primary business segments which include Investment, Automotive, Energy, Gaming, Railcar, Food Packaging, Metals, Real Estate and Home Fashion. This diversification across multiple industries and geographies provides a degree of hedge against economic gyrations.
A recent article in Barron’s stated that, “The company’s largest holding—and biggest winner—is an 82% stake, worth $3.6 billion, in CVR Energy (CVI), a oil-refining and fertilizer company. The MLP purchased 80% of CVR in a tender offer last May at $30 and has seen the shares rise to $50, resulting in a $1.4 billion gain. The second-largest investment is a $2.6 billion stake in the Icahn hedge fund”.
The Icahn Enterprises strategy is described on their website as follows:
“Across all of our businesses, our success is based on a simple formula: we seek to find undervalued companies in the Graham & Dodd tradition. However, while the typical Graham & Dodd value investor purchases undervalued securities and waits for results, we often become actively involved in the companies we target. That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve shareholder value to acquiring a controlling interest or outright ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating and expanding that business. This activism has brought about very strong returns over the years”.
As of 27 February 2013 Icahn Enterprises has produced a total return of 1,003%, when the reinvestment of distributions is included. Over the same period the S&P 500, Dow and Russell 2000 indices increased approximately 32%, 68% and 115%, respectively.
The bottom line
Dividends provide much more than just income. In an era of accounting fraud and earnings scandals dividends provide confidence. That’s because when a dividend is paid, it is paid with money that cannot be faked. Consistently rising dividends also reveal a company’s profitable progress, and dividend trends are more reliable and less erratic than earnings.
The bottom line is that there is no more tangible proof of a return on your investment than receiving a regular dividend payment. In addition, if you buy the right companies at the right price, you are effectively being paid to wait for the market to recognize the true value of your companies.