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Why dividends are good for you in bad times — or good

This U.S. advisory shows just how valuable dividends can be for you in troubled markets like these, and illustrates with four strong stocks.

If investment analysts were nutritionists, they’d keep recommending one source of financial health — dividends. In the rather grim markets we’ve had this winter they’d tell you to step up your intake of dividends, like taking your flu shot or increasing your doses of Vitamin C.

So we’re doubling up on dividends. Yesterday, we recounted Mr. Gordon Pape’s prescription of five Canadian stocks with high dividend yields, delivered to an audience of U.S. investors.

Today we go to Wall Street, and find another measurement of the value of dividends. It comes from an advisory we consult fairly regularly, Dow Theory Forecasts.

The inheritors of the original Wall Street theorist, Mr. Charles Dow, these analysts have a system that demonstrates precisely how comforting dividends can be. They also have a list of four dividend-paying stocks they think are particularly attractive right now.

The most attractive thing about them is that they keep on increasing their dividends.

Thick and thin

Dividends are always valuable, begins the advisory. “The benefits of a tangible income stream are obvious. But dividends also afford some relief from the ups and downs of the stock market, particularly if the payout is increasing.”

Part of the attraction of dividends is that companies have to be fundamentally sound to pay them in the first place. So when you buy a stock that pumps out a regular and rising stream of dividends, you can be pretty sure you’re buying a company that whose deep pockets will carry it through thick and thin.

You can gauge this long-term strength, says the advisory. It has a system for assessing stocks known as Quadrix®. This system judges equities based on more than 100 variables in six categories — Momentum, Quality, Value, Financial Strength, Earnings Estimates, and Performance.

So the advisory set out to measure relative risk. They rated over 2,600 U.S.-traded stocks for the past 60 months, using five more benchmarks: beta (performance relative to the overall market), standard deviation (which measures volatility), up-market performance, down-market performance and worst three-month performance. Based on these, stocks were given a percentile, with 100 the lowest risk, 0 the highest risk.

Having laid down these criteria in some detail, we emerge with some very interesting results.

A win-win situation

The gap between dividend-paying stocks and non-dividend payers is revealing. The 1,338 dividend-paying stocks had a relative risk score of 65, while the non-payers came in at 34.

74 per cent of dividend-payers had a score above 50. Only 26 per cent of the non-payers did. That is, dividend-paying stocks were much more likely to hold up under any conditions, even when their worst three months were taken into account. When times get tough, you are much less likely to see the bottom drop out of their share prices.

Not surprisingly, these stocks also do much better in the fundamental Quadrix scores, earning higher marks in Value, Quality, Financial Strength and Performance.

But there’s a further distinction: stocks whose dividends keep on growing do better than stocks whose dividends remain flat. The relative risk score for the dividend growers is 69. Those with flat or declining payouts scored an average of 56.79 per cent of those with rising dividends did better than 50 in relative risk.

Looked at from this perspective, it looks like a win-win situation for investors: growing dividends are a signal that a stock has a better chance of doing well in all markets. Plus, you reap the benefits of all that extra cash the company is willing to pay out.

Next some examples, starting with a couple of companies that let ducks do a lot of the talking.

The duck and Uncle Walt

Because some bright advertising type thought that the name of this insurance company sounded like a duck quacking, Aflac (NYSE-AFL) may always be associated with a duck the way a certain cereal is with a tiger. But this duck pays dividends, and lots of them.

The company has raised its dividends for 26 straight years. And raised them at an annualized rate of 21 per cent, including a 17 per cent raise this January. Alfac’s December earnings rose 12 per cent, excluding one-time gains and charges, and revenues went up 9 per cent.

While some other U.S. insurers got caught in the subprime squeeze and took large investment losses, Aflac got off the hook for just $1 million, which barely put a dent in earnings.

If you exclude the effects of changes in the yen (the company does a lot of business in Japan), earnings have grown by at least 15 per cent for the last 18 years. For the year ahead, the company expects earnings to grow another 13 to 15 per cent. That should translate into another trip up the ladder for dividends.

Donald Duck has been around a lot longer than his cousin in insurance, but the Walt Disney Company (NYSE-DIS) hasn’t raised its dividends quite as dramatically as Aflac. The dividend is paid once a year, in January, and this year’s $0.35 per share payment represented a tidy 13 per cent increase.

Where Disney has really put its cash to work of late is in share buybacks. $4234 million were bought back in January, on the heels of a $1 billion buyback in December. By the end of January, the buyback authorization stood at 278 million shares, 14 per cent of the shares outstanding. That packs a lot of extra value into the remaining shares.

The much-discussed Hollywood writers’ strike did not hurt Disney a great deal, since film production has longer lead times than TV shows. Studio revenue did not grow in December, but cable TV and theme park revenues grew at double-digit rates.

Flexible rates at the theme parks will help Disney through any recession, as will a weak dollar and solid sales at its international theme parks. Expect more dividends.

More than a utility

Like Aflac, Energen (NYSE-EGN) has raised its dividend for 26 consecutive years. Unlike Aflac, it has no ingratiating spokesfowl. It’s a utility. Traditionally, utilities pay steady dividends, and that’s about as exciting as they get.

But there’s something more to this company, says the advisory. In addition to its regular natural gas distribution network, it has a subsidiary called Alagasco that buys and distributes natural gas, and a division known as Energen Resources that produces natural gas and oil.

The dividend cash comes mostly from the traditional utility, and investors can expect modest regular increases in the payout. But the company has an ace in the hole with its exploration and production operations. Right now it has a oil project in the Alabama shales with “excellent potential,” says the advisory. Three wells have been sunk, and Energen is in for 50 per cent of the take.

Thus investors have reasonable expectations of the best worlds here: steady, stable performance with dividends rising as regularly as clockwork — plus the opportunity for some big earnings growth.

Producing 24/7

Sigma-Aldrich (NASDQ-SIAL) has only been paying dividends since 1994. But it has raised the dividend every year since then. A maker of chemicals and biochemicals for life sciences, this international firm headquartered in St. Louis generates enough cash to keep its dividend growing at double-digit rates.

16 per cent of each dollar turns into free cash flow, and last year’s free cash flow of $339 million was four times the amount paid in dividends.

In fact, the company is growing like some chemical experiment gone out of control. Sales in China, Asia and South America rose 23 per cent in the December quarter. A new manufacturing plant in China will help keep up with Asian demand. With three-quarters of its sales overseas, Sigma-Aldrich won’t be devastated by a U.S. slowdown.

“To accommodate demand and satisfy a near-record order backlog, Sigma plans to begin producing goods 24 hours a day, seven days a week,” says the advisory. That should help them meet consensus expectations for per-share-profit growth of 10 per cent this year. That will be more than enough to cover another increase in the dividend.

Dow Theory Forecasts has two more stocks rated Focus Buys (best buy over the next 12 months) that were not profiled in this issue, but that have raised their dividends in the past three months. They are: copper and gold giant Freeport-McMoRan (NYSE-FCX) and major defense contractor L-3 Communications (NYSE-LLL).

The message is simple: as long as the markets are unhealthy, step up your intake of dividends. You’ll feel much better. In fact, even when the markets get healthy, you can keep on taking in dividends. Apparently, you can never get enough of them.