FYI | Sep 14 2016
By Peter Switzer, Switzer Super Report
Dividend stocks could be beaten up. Here's what to buy!
What you’re going to see in coming months will be talk about dividend stocks being dumped and growth stocks coming back into favour. One US commentator says growth stocks are about “hope”, while stocks for income are about “reality”.
I agree with him but for other reasons that I’ll explain later.
The anti-dividend stocks mutterings were building up last week but the Friday sell off on Wall Street on rising interest rate fears, thanks to the Fed possibly hiking in September, has spooked markets and could quell the anti-dividend talk, for the time being.
We’re now locked into some pre-rate rise market panic but this will only prove to be another buying opportunity for stock accumulators. By the way, smarties will buy in at some time after the sell off but they could wait until the September Fed meeting draws closer or until it’s over. I think there’ll be no change at this meeting.
I think it will be a December thing and then we could see another post-rate-rise-shock happen. Then the reality of a good US economy needing a rate rise will draw smarties back to stocks and growth stocks will do well. Some big funds will sell off their safer and income-paying stocks to chase alpha returns and dividend-paying stocks could fall out of favour.
This will be another buying opportunity for the long-term investor who collects good dividend-payers at good prices to push up the yield-return.
I love being a contrarian with long-term reliable, dividend-paying companies, so I’ll provide you with a group of said companies that I squeezed out of Contango Asset Management’s chief investment officer, George Bourbouras, when I was interviewing him recently.
George and I like these companies because a lot of them here in Australia have a high payout ratio of profits, which come to shareholders as dividends. I can’t see that changing with economic growth worldwide set to be subdued and interest rates expected to be low for a fairly long time.
This is not just my view on rates but that of many banking economists and even Treasury.
When people ask me how I would put a dividend-paying portfolio together, I say you have to think about collecting at least 20 good stocks. I know someone who has held the four big banks and Telstra for the past eight years. For some time he was killing it but lately his capital has been under pressure, though his dividends do remain pretty good. I just think five stocks can leave you open to a crazy government decision or a silly CEO.
Plenty of fund managers will hold 25 to 35 stocks in an income fund or even more, where the goal is to blend the collection of companies so there’s a lot of diversity but, importantly, a good history of paying dividends for the companies in question.
They basically start with the big four banks plus Telstra as natural starting points. If I was starting from scratch myself from now I wouldn’t be afraid to throw in the diversified financials such as AMP and Suncorp, and even some regional banks because of their history of consistent payouts. Bendigo and Adelaide, as well as BOQ fit that bill.
Getting away from financials and companies such as the ASX and CCL have good form in the dividend-paying caper and I’d be looking at some of the utilities such as AGL, Duet and Spark, which give you some mid-cap exposure. You could throw in the likes of Transurban and Macquarie Atlas as well. A lot of experts like Sydney Airport and even Auckland Airport and I could easily live with these great money spinners, with Chinese tourists flocking down under.
A-REITs have done really well and pay good income. For the long-term player looking for income, they should keep delivering but their prices could suffer over the next few years, if growth stocks get the expected thumbs up.
What I have outlined is the way fund managers build up a collection of diverse companies that deliver an income stream. They give constant earnings growth as well, which is important for the sustainability of those all-important dividends.
Over the next few weeks, I’m going to look for lesser-known, consistent, good dividend-payers and I will share them with you.
Of course, another good reason to punt on dividend-payers is the appeal of franking credits and what they can do to your yield. They are critically important and serve to set up a portfolio of these sorts of stocks to punch the annual return to around the 6-7% plus region.
These credits become even more attractive to retirees in zero tax-mode, who can actually get tax refunds. It’s nice to get income from the ATO!
That’s not the end of the section because these companies can have capital growth as well and while their share prices might rise at a slower rate compared to growth stocks, in the next phase of this long drawn out bull market, they can do better than the fast-growing cyclical stocks at other stages of the cycle.
Finally, there’s another big appeal that comes with dividend stocks — they crash better! This is the whole point of a dividend-heavy portfolio. Investors who want to avoid low but very safe returning assets or investment products have to realise that as we are living longer we have to get used to our capital going up and down but, importantly, up again. During the rough times, share prices can slump but dividends, while they can be trimmed back, have a history of defying gravity much better during a crash.
As long as your income is pretty reliable, then you just have to learn that your capital will have about two bad years in 10 but that means it will have eight good ones in 10. Meanwhile your income from stocks — carefully selected for reliable dividends, based on history — will have about nine good years in 10 and maybe just an OK one, if the crash breeds a recession.
For these rough times, I recommend my clients build up a buffer bank account. Here’s an example of how it would work.
Assume you retire with $1 million in your super fund. You take a pension of $70,000 based on your belief that your dividend fund can return 7% on average. Let’s assume your first year is a ripper for the stock market and your return is 10%. In this case, you’d take $30,000 out and slam it into the buffer.
Occasionally taking profit by selling big capital gainers in these boom times also could help build up the buffer as well.
Ideally, you could squirrel this up to $140,000 — two years of income — and that even makes more sense when your portfolio is more risky and less dividend-oriented and so prone to big swings in capital as well as dividends.
On the commentator who thinks growth stocks are about hope, I have always questioned whether hope is a great basis for a plan for a reliable result.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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