By Keith Fitz-Gerald
Money Morning/The Money Map Report
If you want a stable dividend, focus on global companies.
Dividends still matter. But you have to know where to look.
A record setting 367 companies reduced their dividends during the second quarter, no doubt leading many shell-shocked investors to conclude that income is dead.
But there's more to this story. A total of 283 companies actually said that they boosted their payouts, and an even-larger group of companies maintained their current dividend payouts, Standard & Poor's Inc. reported.
Not surprisingly, each of the two groups of companies featured some defining characteristics. The companies that had cut their dividends were largely domestic in nature, or at least had a decidedly domestic emphasis. By and large, the firms that were able to maintain or even boost their quarterly payouts were internationally focused, with the potential for some explosive business growth in the world's key emerging economies.
A Tale of Two Markets
To understand the divergent fortunes of the two groups of companies, just look at the divergent performance of the two world economies that are most talked about today: The United States and China.
At the time of this dividend report's recent release, the U.S. stock-market benchmark – the Standard & Poor's 500 Index – was up a respectable 7.26% so far this year.
By comparison, China's Shenzhen 100 Index had quietly risen 110.10% during that same period.
Such a steep run-up in stock prices often spooks investors. That's understandable. We always evaluate such situations with caution, too.
But while most investors are worried China's stock market could take a tumble, we would look at it as a minor near-term setback – and a major long-term profit opportunity.
Even with the double-digit – or triple-digit – run-ups the stocks of many China-based companies have already experienced, many Chinese companies remain stunningly compelling buys, especially when they feature solid dividend payouts, as well.
And China's not the world's only upbeat investing opportunity. The story is much the same in other parts of the world, too. Right now, there are more than 100 international income funds that feature yields of 6% or better.
So how do you tell which companies have a promising payout future? Or which ones figure to be dividend duds?
There are three key areas to examine.
International Sales: It goes without saying that fast-developing economies such as China and India will almost certainly leave their U.S., European and Japanese counterparts in the dust. Therefore, it makes sense to begin the hunt for the world's best dividend players by looking at companies with a significant business exposure to these and other emerging markets.
If this causes you to step out of your investing "comfort zone," well, let's just say that's great.
Some 74% of the world's economic activity currently takes place beyond U.S. borders, so it makes no more sense to confine yourself to U.S.-only investments than it does to make the same mistake twice.
My favorites include companies that derive 40% or more of their sales from the Pacific Rim, as well as from China. The fact that China's been growing at a double-digit clip for years means that other countries in that region are experiencing spin-off growth. Taiwan, for instance, has solid manufacturing ties with Mainland China – and the relationship between those two one-time political sparring partners is closer than ever, thanks to several trade agreements signed in recent months.
Granted, one can make all sorts of arguments about the sustainability of China's growth, but history shows that you are better off hitching your wagon to strong horses than weak ones. Because most people still tend to view China as a Third-World, Communist-led, economically backward country, they're often stunned to discover that China has had the world's largest gross domestic product (GDP) for 18 of the last 20 centuries.
And it soon will again – and probably a lot sooner than most investors are prepared to accept.
In fact, I'm predicting that China's stock markets could have a larger market capitalization than their U.S. counterparts within the next five years, but that's a story for another time.
Payout Ratios: This is one measure that allows you to gauge the relative security of your investment in any given company. In case you're not familiar with the term, a payout ratio is the percentage of a company's profit that it pays out to shareholders in the form of dividends.
While there are exceptions, if the payout ratio approaches 100%, and the choice I'm considering is not a Canadian Trust or Limited Partnership created expressly for dividend-payout purposes that, to me, constitutes a waving red flag. If business conditions plummet, or management doesn't have as good a handle on cash flow as it thinks it does, any decrease in earnings will obviously affect future dividend payout plans.
On the other hand, if the payout is around 50%, history suggests that this is a sustainable level and that management is unlikely to severely decrease the company's dividend payment. That's barring a catastrophic earnings reversal, of course.
Distribution Source: Thanks to all manner of accounting tricks – politely called "adjustments" in corporate accounting-speak – it's harder than ever to determine where a company's income is coming from. For example, some investments – especially Canadian Income Trusts and shipping partnerships – prefer to pay dividends from available cash flow, as opposed to bottom-line profits, like most other public companies. That can increase the aforementioned payout ratio, and can also mislead investors as to the sustainability of future dividend payments.
But you should look anyway.
Generally speaking, dividends come from earnings, making them reasonably predictable. The stuff that isn't predictable is often the result of special distributions based on short-term or long-term capital gains. Because this type of income often results from one-time sales of assets, or from accounting transactions, they are usually paid semi-annually or annually (as opposed to being paid quarterly, which is the common practice among most U.S. public companies). And while these "special dividends" can provide a nice bump in payments, don't confuse this type of payout with the cash you received from ongoing operations.
The other type of payout that can throw a monkey wrench in things is called a "return-of-capital" event. While it can result in big cash payments that investors enjoy tremendously, it's not a regular payout, either. Like the short-term and long-term distributions we just discussed, return-of-capital transactions are not part of regular earnings. They're typically the result of tax savings, depreciation or other changes in the assets a firm owns. Write-downs and write-ups are good examples of what I'm talking about here.
Either way, return-of-capital transactions are a danger sign in my book because the firm may be trying to return your original investment – which is a strategy often pursued when a dividend cut is imminent and not yet announced.
And that's the last thing you should want right now.
[Editor's Note: As this dividend-strategy story illustrates, the global financial crisis has changed the rules of the investing game forever. Investors who want to succeed will have to look in new places for new types of companies. But just because the process is different, doesn't mean it has to be harder. In fact, Money Morning Investment Director Keith Fitz-Gerald says that the financial crisis has set the stage for a $300 trillion global recovery that will feature some of the most profitable investment opportunities that we'll see in our lifetime. In an upcoming Web summit, which is free of charge, Fitz-Gerald will outline this opportunity, as well as some specific companies global investors might want to consider. To find out more about this free Webinar, please click here.]
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About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.