Morningstar's Josh Peters outlines what dividend investors should look for this earnings season and the odds we'll see higher
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Jeremy Glaser: I'm Jeremy Glaser with Morningstar.com. With earnings season kicking off, what should dividend investors be looking for? Here to talk about this with me is Josh Peters, editor of Morningstar's DividendInvestor newsletter. Josh thanks for joining me. Josh Peters: Happy to be here. Jeremy Glaser: What are the big items that dividend investors should be having an eye out for during this earnings season? Josh Peters: I think what you want to see are signs of stability, that the companies that you own having come through the recession that we've had thus far, that they're starting to see stability in their earnings from quarter to quarter, some improvement. I think it's a little early to expect big increases, big cyclical increases in earnings for most companies, but you want to see that things have at least stabilized, that the situation around a dividend isn't getting any worse. Jeremy Glaser: Through this earnings season, do you expect a lot of corporations to raise their dividends or to discuss the dividend in depth? Josh Peters: I think this time of year you'll actually see a fair amount of discussions. One dividend that has been discussed an awful lot lately is J.P. Morgan Chase, the big investment bank and consumer bank. It looks like they can certainly afford to raise their dividend, but will they decide to do so? There's a lot of uncertainty around what capital ratios will be, what kind of capital ratios banks will be required to hold going forward. Those are likely to change. Standards are going to go up. Certainly a lot of questions about what will the eventual peak look like for loan losses and when, but J.P. Morgan is in an interesting position. They're earning enough revenues, especially on the investment banking side of the business, that they might be among those businesses first able to start raising its dividend off the bottom. Jeremy Glaser: With the slew of data that comes out with the quarterly earnings releases, what should investors key in on to see if there's going to be a dividend increase in the future? What are some metrics that they can take a look at? Josh Peters: Well, here's one thing that I would look at, and it's a little bit of shorthand, a little bit of a trick, if you want to call it that. But think back to when the company made the last change in its dividend, which in a lot of cases if it was an increase you'd be looking back at 2007 or 2008, because a lot of companies skipped dividend increases in 2009 or even cut their dividends. See what kind of payout ratio did the company seem to be targeting at the time. And that should give you some frame of reference for what the dividend will look like going forward. Because I think both before and after the crisis, you're going to want to see companies, if they've been paying out let's say 40% of their earnings, that's probably a figure that they figure works well for them. But if the earnings are depressed and let's say that payout ratio is 80%, because they're only earning half of what they used to, then it may be some time before you get good dividend growth. Some companies make a practice, ever year they raise the dividend. They're on the dividend achievers list or S&P's Dividend Aristocrats list. It might keep that dividend increase streak alive, but you're not going to see real growth until you get earnings back up to where they were before the decline. Jeremy Glaser: Given the magnitude of the crisis, do you think any management teams are now more skeptical about paying out so much capital in dividends and that they'll return to a lower payout ratio than they had before? Josh Peters: That's a great question and, of course, like all the greatest questions you can ask somebody, it's the one that's the hardest to answer. I can really see two pretty good scenarios. You know, if I sat myself in a board of directors meeting, how would I be thinking about this. On the one hand, during the financial crisis, we saw a lot of companies that never expected to have any trouble borrowing money, never had any trouble accessing the capital markets before all of a sudden found themselves cut off, very uncomfortable— very unpleasant type of situations. Even for companies like utilities that happened to borrow a lot of money, very steady businesses, but if nobody can borrow money, not even a utility that can cause a lot of problems. If you're sitting there as a finance officer or director of a company like that, maybe you say, "You know what, we want an extra cushion. We want to pay down our debt. We want to increase our cash balances, just hoard cash, so that we don't ever get into that kind of trouble again." That's the one scenario. On the other hand, you have now a good 10-year record that counting on capital appreciation, counting on capital gains to reward your shareholders isn't working. You know, it's been a terrible decade for investors. They haven't realized gains. What little profits they may have had have been coming from dividends. And because those dividends were small, so also were total returns across this market small. I think a lot of forward-looking companies, progressive companies are going to say, “You know what, we have to do more than just try to grow the business and assume that the market will take care of our shareholders. We have to take care of them directly by providing a good income.” Especially as people are retiring, looking at how they're going to earn a good income, a good regular paycheck from their portfolios. This is very important for companies to think about. That would weigh in favor of bigger dividends, higher payout ratios, more of the company's earnings going out as dividends as opposed to being retained to try to grow the company or to buy back shares. And another thing we find out in the last decade didn't really work all that well for shareholders. But really kind of a tug of war here between trying to take advantage of dividend policy to reward shareholders directly, create a more loyal shareholder base, serves people's need for income. And that conservatism of we don't want to have another panic that could potentially blow the company apart. I think it's going to be a couple of years to see which of these two scenarios tends to dominate. I think it's really too early for the market as a whole to tell. The good news is for the companies that have come through this crisis, haven't cut their dividends, didn't have to resort to extraordinary measures like huge equity issues to try to bolster their balance sheets, because they were in trouble in the first place. I think we can continue to expect regular dividend increases from those kinds of companies. They're your Johnson & Johnson’s, your General Mills, Altria Group, things like this. They're going to continue to meet those commitments even though there's a lot of uncertainty in other segments of the market. Jeremy Glaser: Thanks, Josh. It gives us some interesting things to think about during this earnings season. Josh Peters: It is interesting, and we'll see how it plays out. But like I said, I don't think you have to make a wild bet on just any company about paying a dividend. You can stick with the companies that have already shown you what they're going to do by doing it. Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser.