Microsoft's announcement that it will start paying a dividend is a watershed, especially for technology companies and for dividend-reinvestment plans (DRIPs -- in which a stockholder agrees to have his or her dividends used to purchase more of the company's stock). That's the word from Chuck Carlson, CEO of Horizon Publishing and Horizon Investment Services -- and editor of the DRIP Investor newsletter.
The news came in the wake of President George Bush's proposal to eliminate taxes on dividend income. Carlson is a strong proponent of the Bush plan, although he's not sure "all the good stuff" will win approval from Congress. He thinks investors are taking a wait-and-see attitude for now.
Carlson noted that Microsoft (MSFT) will also start selling shares directly to investors and that this move, coupled with the dividend announcement, could "jump-start" dividend payments and DRIPs in other tech companies, such as Oracle (ORCL) and Cisco. He cautions, however, that not many tech businesses "have lots of cash and the type of consistent performance that lends itself to paying a dividend."
Carlson made these points and more in an investing chat presented Jan. 16 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Edited excerpts from this chat follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Chuck, what's your big-picture view of the stock market right now?
A: I'm reasonably bullish on the market through the first quarter of 2003. I get a little bit more concerned after that, because to support higher stock prices later this year, you will need to have more robust growth in corporate profits than we've had in the last few quarters. I happen to think that we'll get the type of corporate earnings growth that will support higher prices, but that certainly is not a given.
Q: What do you think of Bush's stimulus package [which includes the dividend tax cut]? Do you think investors are waiting to see what gets passed?
A: I like the plan a great deal for a number of reasons. First, I think any time you increase aftertax returns on investments, that's good news for the stock market and ultimately good news for the economy. This proposal does exactly that.... I do believe that investors, after their initial euphoria, are now taking a wait-and-see attitude as to what actually becomes law. My guess is that it will be very difficult for all of the good stuff to get passed by Congress. Nevertheless, I do think Bush has the political capital right now to get through much of what he's proposing.
Q: What are you recommending for utilities paying safe dividends?
A: One way to play the utility sector is with the Dow Jones Utilities exchange-traded fund (IDU). This provides a way to own a basket of utility stocks, yet trade that basket like a stock. For individual utility investments, I think the natural-gas utility Vectren (VVC) is attractive. For more aggressive investors, I think Teco Energy (TE) has interesting rebound potential.
Q: Which companies that pay dividends don't have any debt? Or only little debt? Is that a measure that concerns you in relation to dividends?
A: Let me answer the second question first. I do look at debt when looking at companies. You have to these days, given that many companies are carrying lots of debt, thus making them vulnerable to continued weakness in the economy, not to mention the potential for dividend cuts. Interestingly...I think investors need to look beyond just the debt number and see when that debt is maturing. This is a very key factor. A company that has lots of debt coming due over the next 6 to 12 months may run into problems refinancing it.
However, one of the things we look at while trying to evaluate the safety of a dividend is what's called a payout ratio. The payout ratio is determined by dividing the company's dividends by its earnings per share. Thus, a company that pays out $1 in dividends out of its $2 in earnings has a payout ratio of 50%. Obviously, the higher a company's payout ratio, the less cushion the it has for raising its dividends.
Investors looking for dividend champion stocks may want to consider the following: Anheuser-Busch (BUD), Coca-Cola (KO), Exxon Mobil (XOM), Gannett (GCI), Pfizer (PFE), Johnson & Johnson (JNJ), and Walgreen (WAG). These companies have all paid dividends for 50 years and have raised their dividends over the last decade.
Q: How will REITs react to the dividend tax plan? There seems to be confusion about this.
A: Conventional wisdom says REITs will be one of the losers under the plan. That's because the dividends paid by REITs are not expected to be exempt from taxes. Thus, the relative gap in aftertax yield between REITs and other income investments shrinks if the plan is approved.
My take, however, is that while REITs may have a brief negative response to the plan, owning a quality REIT or two lends nice diversification to an overall portfolio. For that reason, while I would not want to make REITs more than, say, 5% of a portfolio, I would feel comfortable owning the good ones. One of my favorite REITs is Duke Realty (DRE). The stock yields around 7%. I think Duke is a quality holding and one that represents good value in a portfolio.
Q: What are some of the better DRIPs? Have DRIPs maintained popularity since the market began falling off? And will the tax proposal affect them?
A: Actually, I have seen renewed interest in DRIP plans in the last 18 months, [and this] stems from several factors. First, I think investors are coming back to more of the tried-and-true ways of investing, and the DRIP style of investing has stood the test of time. Second, I think the renewed interest in dividend stocks, not just recently but over the last 18 months during this rocky market, has also increased the appeal of DRIPs in many investors' eyes. Finally, DRIPs are an excellent way for investors to tiptoe back into this market.
A few DRIPs that look especially attractive to me include Pfizer, the drug giant. Pfizer permits any investor to make his or her initial investment directly -- minimal original investment of just $500. Furthermore, Pfizer does not charge a penny in commission to buy through the plan. Another one that looks interesting to me is Walgreen, the drugstore chain. These shares have pulled back over the last few weeks and are offering a good buying opportunity. Walgreen permits investors to make initial purchases directly with just $50.
Q: Will municipal bonds lose their advantage [in Bush's tax plan]?
A: What Bush's plan does is provide one more advantage toward equities vs. fixed-income investments. Now, I know some investors out there will never buy stocks because of their high risk and will always stick with fixed income. Nevertheless, I know that there are investors who are always at the margin, who are trying to decide whether to buy fixed-income investments or dividend-paying stocks. For them, they've just been given another reason to buy stocks. Therefore, I do believe you'll see some pressure on fixed-income investments, including municipal bonds.
Q: Microsoft has just announced it will pay a dividend.
A: It just announced minutes ago. It plans to pay 16 cents a share, beginning in March, 2003. Since Microsoft also announced that it will split its stock 2 for 1, the dividend on the post-split share will be 8 cents per share. Also, for DRIP investors, Microsoft announced that it will be introducing a direct stock-purchase plan that will allow any investor to buy stock directly from the company. In my mind, this is a huge development for DRIP plans, as it will hopefully jump-start new DRIPs in the tech sector, an area that has traditionally not had many DRIP plans from which to choose.
Q: So do you think more tech companies, like Cisco Systems (CSCO), will follow suit?
A: I think it's likely that you will see more tech companies do that. However, keep in mind that truly only a handful of tech companies have lots of cash and the type of consistent performance that lends itself to paying a dividend. Therefore, I do not expect the floodgates to open, with all the techs paying dividends. However, I would not be surprised to see both Oracle and Cisco take their cue from Microsoft and implement dividends.
[However,] keep in mind that growth companies don't like to signal that they're not growth companies anymore. That's why many growth companies don't pay dividends. They're generally associated with nongrowth companies.
Q: Over to banks -- your thoughts on Popular (BPOP)? Any hope for a dividend increase or split?
A: As my newsletter subscribers know, I have been a big booster of Popular. The outfit is the holding company for Banco Popular. The bank, based in Puerto Rico, has outlets in major urban areas throughout the U.S. I like Popular because it provides an interesting way to play the growth of an important demographic group, that being Hispanics. The Hispanic population is growing faster than virtually any other ethnic group in the U.S., and Popular is the biggest banker to this group. I would expect dividend increases but not a stock split anytime soon.
Q: Duke Energy (DUK) -- any thoughts?
A: I have to admit that I've been a bull on Duke Energy in recent weeks. I'm intrigued with the rebound prospects for utility stocks that have been beaten up over the last 18 months. Furthermore, I think the President's tax plan will help dividend stocks like the utilities. Therefore, I see two factors driving these stocks higher in 2003.
Having said that, Duke Energy's recent earnings disappointment will likely keep a lid on the stock for the next three months. If your time frame is 12 months or longer, I might consider picking up a few shares at these present prices.
Q: What is your take on ChevronTexaco (CVX)? It pays about a 4% dividend with some good upside potential.
A: I like the stock. I like its yield of more than 4%, and I like its moderate valuation. To be sure, the company has been having some merger pains, and investors are likely to make other plays in the group. However, I would feel comfortable buying the stock at these prices.
Q: The dividend tax proposal has run into controversy -- what do you expect the impact would be if it fails?
A: Well, I do believe there's already a built-in bias toward the plan in the stock market. Thus, I would expect a failure of any part of the plan to have negative ramifications. It's more difficult to assess how a trimmed-down version would affect the market. I would say that while the market has benefited from the plan, there are enough investors on the sidelines who would be drawn in by approval, so I don't think we've seen the full upside from the plan yet.
Q: Banks and utilities are traditionally good sectors for dividends -- have there been any recent shifts in the best places to look for dividends?
A: I think people would be surprised to see the sort of yields that are now available in many health-care-related stocks. The pullback in the group over the last 18 months has lifted the yields on a number of the stocks in that group. Likewise, I think the consumer-products sector has a number of quality issues that are yielding at least as much as the S&P 500 index.
Q: Chuck, how can investors find dividend information? I know your Web site is very useful.
A: Yes. I'm biased, but I think our Web site (www.dripinvestor.com) provides a lot of good information. We also publish a monthly newsletter on DRIPs, DRIP Investor. To obtain a sample copy, go to the Web site. Also, if you're wondering about a company, a call to the firm's shareholder-services department will let you know if it offers a DRIP or not.