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Jeremy Glaser: I’m Jeremy Glaser with Morningstar.com. I’m here today with Josh Peters, Editor of Morningstar Dividend Investor to find out exactly what makes a dividend stock tick. Thanks for joining with me Josh.
John Peters: Happily come around to talk about my favorite subject.
Jeremy Glaser: Which is a dividend stock?
John Peters: It is dividend stock. That’s pretty much what I eat, sleep and breathe.
Jeremy Glaser: So what exactly should investors be thinking about it they are going to invest in dividend paying stocks?
John Peters: I think that the main point is you don’t want to think just in terms of yield, although yield is very important. You don’t want to think just in terms of growth whether that’s a growth of the dividend, growth of earnings, growth of the share price. You want to yield and the growth. Yield and growth both in other words and that’s a concept that would call total return.
In total return is what really adds up and compounds for investors overtime. You can't think strictly in terms of price appreciation in carrying the day, its got to be that combination that works for you.
Jeremy Glaser: So how can you find a dividend paying stocks that are going to give you that good total of return overtime?
John Peters: The way I’d like to think about it is that it’s a mix. I think it pretty common from most investors and stocks to think in terms of a 9, 10, 11% average total return from their stocks. This is kind of what we were brought up in the stock market to expect. Its kind of inline with the long run averages, no one 1:26 perhaps but its kind of a baseline expectation for going forward.
What I do is I think in terms of whatever I’m not getting from yield than I want to get from growth or vice versa. So let’s take a stock like Johnson and Johnson for example which he yields right about 3%. If the dividend can grow 8% a year, I can add that 3% dividend yield to the 8% dividend growth rate and anticipate in 11% average total return. The way that works is not only as the dividend growing in providing more income, but historically as Johnson and Johnson dividend has gone up has also its stock price gone out. So its capital gains overtime are correlated to the dividend, correlated to the earnings as well which pay the dividends.
So these two factors, they really simplifies the process. You know 3 + 8 = 11. This is what I have some room to expect then if you add a little additional principal, margin of safety you might think in terms; well I want to earn at least nine. So from Johnson and Johnson as long as it grow 6% a year, I don’t need the eight if it earns 6% a year plus the 3% yield then I’m earning a decent total return.
Jeremy Glaser: What do you think the idea of max between yield and growth is?
John Peters: I think its going to be different for different investors. If you have the opportunity to get a lot more growth and exchange for taking a lower yield, if you’re relatively young, you have a long ways to go to save and invest before you get to retirement, then lower yielding stocks might make more sense. Johnson and Johnson perhaps a good example.
3% is not the kind of income yield that a lot of retirees are necessarily going to find attractive. But if their dividend grows 8% a year, its going too doubled would it that be every 9 years and presumably, stock price should follow along. It’s got a lot way to compound in advance of eventually starting to casual dividends out in using them for paychecks in retirement. If you’re looking for a current income immediately, then a stock like realty income is one that I find more attractive. It’s a real estate investment trust, very simple business. It’s a landlord long term leases to single tenant retail properties. The dividend deal there is in the 65 area. A little better than 6%.
Dividends not going to grow anywhere near as fast as Johnson and Johnson’s. I think maybe for 4 1/2 % a year. The overall total return is a little lower than Johnson and Johnson might offer but that cash portion that you can use to fund your lifestyle and retirement is much larger. Less growth but a lot more yield. So in that type of situation, you can almost see yourself matching up, different types of companies total return profiles to their own investment needs.
Jeremy Glaser: Sometimes it seems investors are valuing yield over growth and sometimes did vice versa. What do you think the market investors are thinking right now?
John Peters: Well, I would say that in a market overall, the yields less than 2%, you’ve got a lot of people expecting a lot of growth. I mean historical first year dividend growth rates have been maybe 5, 6% a year. You tact that on to the 2% yield to that of the SNP 500, you’re looking at a pretty poor over a return from the stock market overall. That being said, a lot of investors now are starting to think more in terms of income. Stock market isn’t shooting up quite the way it was earlier in the year and a bit most vigorous part of the rebound rally. Interest rates still very, very low by historic standards and people are starting dividend yield is the same, it’s better than what I get at the bank.
And this is where I always seem to be leaning against the wind. I really emphasize the dividend yield up until the last couple of weeks saying, here's an opportunity, get a much more predictable return compared to all of wild volatility we’ve had to put up with on a stock price side and the growth side of the equation. Now, we’re starting to see a situation where investors are beating up the higher yielding stocks without necessarily paying attention to their growth prospects.
Higher yield in drug companies for example. 5:23 Mayer’s Merk, they’re moving up faster now than Johnson and Johnson 5:28 laboratories. Now they yield for 5% instead of 3% for Johnson and Johnson inhabit but J and J inhabit are going to grow much faster going forward. You may not get any dividend growth out of Merk, Lily or 5:39 at all. Johnson and Johnson out of webs are often a much better to overall total return prospect even though their yields are lower because their going to generate double or triple the amount of growth.
Jeremy Glaser: Investors should definitely keep an eye for that then.
John Peters: Yeah and it all comes back to the same bottom line. Its not just yield, its not just growth, its both.
Jeremy Glaser: Thanks so much for talking with me today Josh.
John Peters: Happy to join you.
Jeremy Glaser: For Morningstar.com, I’m Jeremy Glaser.