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June 11, 2008 Don't live and die by dividends Once upon a time, dividends were more important than capital gains. From 1926 through 1950, dividends accounted for more than half of the total returns of large-company stocks. However, dividend yields have declined over time, as companies gradually reduced the percentage of profits distributed as dividends. In the last decade, yields fell to unusually low levels, in part because stock repurchases gained popularity, and companies that wished to share the wealth with stockholders increasingly did it through buybacks rather than dividends. Of course, dividends remain of crucial importance to investors, and not just to those dependent on income from their portfolios. Dividends provide a cash return even during periods when stock prices are declining. In addition, the market often views dividend-paying stocks as less risky, although many dividend stocks have performed abysmally over the past year. In 2007, companies in the S&P 500 paid out more than $246 billion in dividends. The index’s per-share payout has risen at an annualized rate of 5.6% over the last 19 years, with gains in each of the last six calendar years. Yet over that period, the index’s dividend yield has declined substantially — to 2.1% at the end of March 2008 from 3.4% at the end of March 1989. Why the falling yield? Blame the index’s price. Over the last 19 years, the S&P 500 Index’s price has outpaced dividend growth, rising at an annualized rate of 8.2%, driven by per-share-earnings growth of 7.4%. With capital gains accounting for such a high percentage of stock returns, the Forecasts’ focus on total returns rather than just yield makes sense. That’s not to say we ignore dividends — we like dividend-paying stocks, but prefer to focus on companies that increase the payout regularly. Good stocks with high yields are hard to find these days, a development that seems logical when you consider how the overall market yield has fallen. In January 1990, 28% of S&P 500 stocks yielded more than 4%. At the end of April 2008, just 13% of stocks in the index yielded more than 4%. Investors seeking dividends should consider two questions: *How high is the payout ratio?* Several high-profile dividend cuts in recent weeks are reminders that investors should consider whether companies they own can afford to pay their dividends. To calculate the payout ratio for stocks, we divide the indicated year-ahead dividend by estimated year-ahead earnings. For the most part, we prefer payout ratios below 60%, which suggest companies have the financial flexibility to invest in their business and deal with downturns. *Do your stocks have sufficient profit-growth potential to support higher payouts?* Every time a company raises the dividend, it not only boosts investors’ income, but also makes a statement about its own financial strength and confidence in the future. Three stocks are reviewed in the following paragraphs. Aflac ($66; NYSE: AFL) has grown its dividend at an annualized rate of 20% over the last 15 years. Supporting that payout has been annualized growth of more than 9% in sales and 17% in per-share profits. The insurer pays out less than a quarter of its profits in dividends, which provides plenty of flexibility for future increases. Japan accounts for more than 70% of Aflac’s revenue, and new products and distribution outlets should drive double-digit profit growth in Japan over the next two to three years. By the end of April, at least 90 Japanese banks had agreed to sell Aflac insurance. By the middle of this year, Aflac expects to have signed up 150 bank partners in Japan. Bank channels accounted for just 1% of new sales in the March quarter. That proportion should rise rapidly. In October, Aflac will also begin selling through the Japanese post office’s 300 branches. These new outlets allow the company to expand its sales locations beyond worksites, where it has traditionally generated most new business. A new cancer-insurance product also helped boost Japanese sales in the March quarter. With cancer the No. 1 cause of death in Japan and patients facing a higher deductible for the national health plan, the product is well-positioned in a growing market. Aflac is a Long-Term Buy.
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June 11, 2008

Don't live and die by dividends

Once upon a time, dividends were more important than capital gains.

From 1926 through 1950, dividends accounted for more than half of the total returns of large-company stocks. However, dividend yields have declined over time, as companies gradually reduced the percentage of profits distributed as dividends. In the last decade, yields fell to unusually low levels, in part because stock repurchases gained popularity, and companies that wished to share the wealth with stockholders increasingly did it through buybacks rather than dividends.

Of course, dividends remain of crucial importance to investors, and not just to those dependent on income from their portfolios. Dividends provide a cash return even during periods when stock prices are declining. In addition, the market often views dividend-paying stocks as less risky, although many dividend stocks have performed abysmally over the past year.

In 2007, companies in the S&P 500 paid out more than $246 billion in dividends. The index’s per-share payout has risen at an annualized rate of 5.6% over the last 19 years, with gains in each of the last six calendar years. Yet over that period, the index’s dividend yield has declined substantially — to 2.1% at the end of March 2008 from 3.4% at the end of March 1989. Why the falling yield? Blame the index’s price.

Over the last 19 years, the S&P 500 Index’s price has outpaced dividend growth, rising at an annualized rate of 8.2%, driven by per-share-earnings growth of 7.4%.

With capital gains accounting for such a high percentage of stock returns, the Forecasts’ focus on total returns rather than just yield makes sense. That’s not to say we ignore dividends — we like dividend-paying stocks, but prefer to focus on companies that increase the payout regularly.

Good stocks with high yields are hard to find these days, a development that seems logical when you consider how the overall market yield has fallen. In January 1990, 28% of S&P 500 stocks yielded more than 4%. At the end of April 2008, just 13% of stocks in the index yielded more than 4%.

Investors seeking dividends should consider two questions:

How high is the payout ratio? Several high-profile dividend cuts in recent weeks are reminders that investors should consider whether companies they own can afford to pay their dividends. To calculate the payout ratio for stocks, we divide the indicated year-ahead dividend by estimated year-ahead earnings. For the most part, we prefer payout ratios below 60%, which suggest companies have the financial flexibility to invest in their business and deal with downturns.

Do your stocks have sufficient profit-growth potential to support higher payouts? Every time a company raises the dividend, it not only boosts investors’ income, but also makes a statement about its own financial strength and confidence in the future. Three stocks are reviewed in the following paragraphs.

Aflac ($66; NYSE: AFL) has grown its dividend at an annualized rate of 20% over the last 15 years. Supporting that payout has been annualized growth of more than 9% in sales and 17% in per-share profits. The insurer pays out less than a quarter of its profits in dividends, which provides plenty of flexibility for future increases.

Japan accounts for more than 70% of Aflac’s revenue, and new products and distribution outlets should drive double-digit profit growth in Japan over the next two to three years. By the end of April, at least 90 Japanese banks had agreed to sell Aflac insurance. By the middle of this year, Aflac expects to have signed up 150 bank partners in Japan. Bank channels accounted for just 1% of new sales in the March quarter. That proportion should rise rapidly. In October, Aflac will also begin selling through the Japanese post office’s 300 branches. These new outlets allow the company to expand its sales locations beyond worksites, where it has traditionally generated most new business.

A new cancer-insurance product also helped boost Japanese sales in the March quarter. With cancer the No. 1 cause of death in Japan and patients facing a higher deductible for the national health plan, the product is well-positioned in a growing market. Aflac is a Long-Term Buy.