Investors looking for yield plays will find slim pickings in the Standard & Poor’s 500 index. Recent dividend yields have averaged 1.7 percent, not far above their all-time low of 1.1 percent, hit near the 2000 market peak, and well below the 20-year high of 5 percent that prevailed through much of 1984.
It’s a different story abroad, particularly in Europe and Australia. The dividend yield on the FTSE all share index, for instance, is 3.17 percent; Italy’s MIB index offers a 3.68 percent payout and Australia’s S&P all ordinaries index, 3.71 percent. What’s more, the S&P 500 is pricey, trading at a price-earnings ratio of 20.3, versus the Dow Jones world index multiple of 17 and the Euro Stoxx 50 at 13.8.
Increasingly, the high dividend rates available in relatively inexpensive markets have money managers looking outside the U.S. for opportunities. “There’s no doubt that dividends will continue to play an important part in total equity performance,” says Scott Clemons, a managing director at Brown Brothers Harriman in New York. “Historically, dividends have accounted for 40 percent of total returns. Accordingly, we believe that investors can find higher-yielding stocks and higher total returns by looking abroad -- and without taking on significant additional risk.”
What’s more, Clemons notes, European markets offer investors a wider range of sectors with higher-yielding stocks than can easily be found in the U.S.
Further, although U.S. CEOs can be quick to cut dividends when earnings weaken, their European colleagues are more reluctant to pull the trigger. Says Gareth Williams, the London-based European strategist for Lehman Brothers, “If a European company falls on hard times, maintenance of the dividend remains a crucial element in retaining investor confidence.”
Brad Kinkelaar, co-manager of the $410 million Thornburg Investment Income Builder Fund, currently keeps 40 percent of his assets in European and Asian equities, up from less than 30 percent in the first quarter of 2003. Kinkelaar screens globally for stocks with attractive yields that are selling at a significant discount to their intrinsic value. He particularly looks for companies with the ability and willingness to grow their dividends.
Currently, the Thornburg fund has an average earnings growth rate of 12 percent, compared with 14 percent for the S&P 500. However, the fund’s 2005 estimated P/E is much lower: 12.9 percent versus 16.8 percent. “Our portfolio has growth characteristics comparable to those of the S&P 500, but it sells at a significantly discounted valuation,” Kinkelaar says. “Coupled with attractive and growing dividends, this should allow our portfolio to excel over the long term.”
The fund has posted a solid track record since it was launched in December 2002. In 2003 it returned 32.1 percent, slightly less than the 33.3 percent average for Morningstar’s international stock funds but well ahead of the 28.7 percent return for the S&P 500. This year through October 29, it’s up 6.8 percent, versus 2.9 percent for the S&P 500 and 6.3 percent for the average international stock fund.
British retailer Tesco helped propel that performance. Kinkelaar, a longtime follower of the $40.5 billion British grocery giant, was attracted by the company’s ten-year annualized dividend growth rate of 10 percent and a payout ratio that has held steady at a sustainable 29 percent of cash flow. Shares were selling for a modest seven times price-to-cash-flow after falling 35 percent in 2002. And Kinkelaar saw promise in Tesco’s proposed expansion plans.
Kinkelaar established a major stake, 3.1 percent of fund assets, or $12.5 million, in March 2003, when the stock was trading at £1.72 ($2.72) and yielding nearly 4 percent.
Since then Tesco has increased sales of profitable non-food-related items, such as appliances, while continuing to expand into Eastern Europe and Southeast Asia. Profits are rising about 12 percent a year. In late October 2004 the stock traded at £2.87, giving Kinkelaar a gain of more than 65 percent on his investment.
“Tesco was close to an ideal buy,” explains Kinkelaar. “Its shares were very cheap, offering a yield comparable to ten-year Treasuries, while the company was committed and able to grow its dividend based on a compelling growth outlook.”
Kinkelaar was also attracted to Australia’s $1.6 billion (market cap) APN News and Media. During the past five years, it reported annual earnings-per-share and dividend growth of 20 percent and 13 percent, respectively. In March 2004, when Kinkelaar purchased shares of APN, the dividend yield was 4.3 percent. And although the trailing P/E of 17 was higher than that of most stocks in his portfolio, it was less expensive than those of other Australian media companies, which trade at 20 times earnings.
Kinkelaar invested 1.5 percent of fund assets in APN shares at A$3.79 ($2.80). Over the next six months, the stock gained 23 percent on the back of an improving domestic economy and a resurgence in advertising spending.
Kinkelaar has expanded his value search beyond Europe and Australia to the fast-growing Chinese economy. There he discovered Shenzen Chiwan Wharf, a relatively obscure transportation-related services outfit. What makes the small, $873 million firm appealing is that it owns some of the valuable mainland docks just opposite Hong Kong at the mouth of the Pearl River, the area where China’s manufacturing industry is centered.
SCW reported earnings growth of 70 percent in 2003 and expects a 40 percent gain this year. What’s more, it has a price-to-cash-flow ratio of 8, a history of consistent dividend increases and a current yield of 3.8 percent. Kinkelaar invested nearly 1 percent of his fund, or about $4 million, in June 2004 at HK$11.85 ($1.52). In just four months, through the beginning of October, shares were up more than 10 percent as cargo shipments up and down the Pearl River continued to increase, boosting revenues and profits.
Glen Hilton, coportfolio manager of the $50 million AIM Global Value Fund, is partial to high-yielding Canadian equities, keeping 28 percent of fund assets north of the border. “We’re overweight Canadian securities because the economy is steadily expanding,” Hilton notes. “Yields are higher, and we expect the currency to continue to strengthen against the dollar, giving our portfolio an added boost.”
His fund focuses on low-volatility investments that can deliver consistent total returns. Hilton and his staff take a bottom-up approach to stock picking, searching for steady performers with reasonable valuations and above-average yield. “Given choppy market conditions across most of the globe,” says Hilton, “we emphasize capital preservation -- winning by not losing.”
During the 36 months ended October 28, the fund returned an annualized average of 11.5 percent, 76 basis points better than the average for Morningstar’s international stock funds and nearly 9 percentage points a year ahead of the S&P 500.
Hilton’s top holding, 2.1 percent of fund assets, is in Fording Canadian Coal Trust Co., a Calgary-based coal producer that was yielding 7.85 percent when Hilton acquired his stake in early 2004 at an average cost of C$50 ($38.82). The $2.8 billion trust is obliged to distribute nearly all of its earnings to shareholders in the form of dividends, which have been increasing by 10 percent a year since 2001. “The underlying soundness of the company and the strong demand for commodities,” explains Hilton, “have helped drive the stock up 50 percent since we first bought it.”
Raymond Mills, portfolio manager of T. Rowe Price’s $438 million International Growth & Income Fund, has a mandate to pursue capital appreciation by investing in established, dividend-yielding foreign equities. His portfolio carries an average dividend yield of 3 percent. Through October 28, one-year returns were 23.9 percent and three-year returns were 12.23 percent, topping Morningstar’s international stock fund average total returns of 15.41 percent and 10.74 percent, respectively.
Among the fund’s most intriguing plays is the $2.1 billion Swedish specialty steel firm SSAB, which has a dividend yield of 4.2 percent. “The steel industry is becoming increasingly attractive because of rising global demand, especially out of China,” explains Mills. “Also, capacity reduction brought about through mergers is improving pricing power.”
In early 2003, Mills saw that SSAB was selling for not much more than book value while offering a substantial yield. Around the same time, the company’s management was pursuing a plant modernization program. During the second half of last year, Mills gradually acquired a stake representing 0.5 percent of his fund’s assets; his total return for the 12 months through late October is more than 30 percent.
Ferreting out such opportunities can certainly be rewarding. Research by Morgan Stanley’s London-based U.K. strategist Graham Secker suggests that buying high-yielding stocks pays off over the long term. In a recent report he noted that £100 invested in 1989 in the FTSE all share index would have been worth £238 in October 2004. But if the same £100 had been invested in the U.K. growth stock with the highest dividends, the portfolio would have been worth £829.
