There’s been much speculation about the timing of the end of the Federal Reserve’s longstanding quantitative easing program, and when yields on Treasuries and other fixed-income investments could rise. If yields are going to rise, you might be asking: “do dividends really matter?” We think they matter for a few reasons.
While we don’t know when the Fed’s quantitative easing program will actually end, and even when it does end, that doesn’t necessarily mean the Fed will start tightening rates. Fed policymakers have been saying they are focused on employment, so if employment doesn’t improve, we won’t likely see QE come to an abrupt halt. You also need to consider where all the money the Fed has already pumped into the system is now. The way we see it, banks have been strengthening their balance sheets and holding Treasuries, and now they seem more willing to lend. That money should eventually find its way into equities, and we believe that’s part of what may have been driving the US market to new heights this year. Monetary policy takes time to work, so even if the Fed isn’t pumping more new money in, there’s a lot already out there.
Additionally, the Japanese have launched their own US$2 trillion easing program this year, and another US$2.7 trillion is anticipated next year. The Europeans are also focused on stimulating their economies. The European Central Bank’s main short-term interest rate is now under 1.0%. So considering government bonds are currently yielding next to nothing in many countries, I think dividend-paying stocks could remain appealing.
The Dividend Story
Dividends are very important, not just because investors like to receive the income they can potentially offer. We think dividends can be an indicator of good corporate governance. In the past, most companies in emerging markets preferred to put profits back into their businesses, rather than pay it out to shareholders. But today more are engaging in dividend payouts, and we think this is a good thing. If a company is giving dividends to shareholders and still has enough cash left over to expand and make needed capital investments, it’s very positive in our view. We find companies with a history of paying dividends particularly attractive to us. If a company’s management team is focused on the best interest of shareholders, we think they can be more successful.
In some cases, the emerging market dividend story is driven by policy and politics. In Brazil, companies are legally required to pay out at least 25% of their net profits in the form of dividends. A number of companies actually pay out more than that. And in some cases, governments who turn state-controlled enterprises loose (i.e., privatize them) remain large stakeholders, and benefit directly from dividend payouts. Dividends generally send a shareholder-friendly message that attracts foreign investors. However, it’s important to note that a company with poor corporate governance in other areas or a weak business model isn’t going to be transformed just by pursuing a dividend policy to boost its image. It still must have strong prospects and deliver results. We spend a great deal of time doing in-depth research on every company we invest in and this is an area where we believe an active management approach to investing has the potential to add value.
In the first half of 2013, emerging market companies have been paying out an estimated 30 -35% of retained earnings in the form of dividends1. Of course, in some countries, the payout ratios are much higher and, in others, lower.
The average dividend yield2, which represents the ratio of dividends to the share price, currently stands at about 2.8% for emerging market equities3.
Opportunity Arises in Asia
Emerging markets in Asia represent a particularly good universe of companies with a record of paying dividends. According to our research, there are more than 18,000 actively listed companies in Asia (excluding Japan, New Zealand and Australia), of which close to 9,000 paid dividends in the past 12 months. And, many are yielding 3% or better. Gaming, telecoms, banks and property are sectors of particular interest to us in this region. That doesn’t mean, of course, that we will invest in all of them. We prefer a history of steady and consistent pay-outs rather than huge fluctuations. And we are selective stock pickers. We also must analyze many other factors related to a company’s financial condition as we make our long-term projections.
In recent months, investors seemed to have turned cautious on Asian markets, but we think they still hold potential. Even allowing for a degree of uncertainty about Asian growth rates, various forecasters expect Asia’s GDP to grow at a faster rate than that of developed markets. And governments in a number of countries across Asia have been enacting market reforms. China is the most notable case, with moves to partially liberalize the banking and energy markets buttressed by early initiatives to reform the “hukou” household registration policy that has been seen as a barrier to urbanization and the development of a strong consumer economy.
While currency weakness in a number of Asian markets is a symptom of investor unease, it also has the effect of increasing the competitiveness of export businesses in the region. In spite of such positive developments and what we see as the potential for strong growth in corporate profitability in the long term, current equity valuations in Asia lag global peers in many cases. Our stock-by-stock fundamental research metrics continue to suggest the presence of many potentially attractive investment opportunities within the region.
A Place for Dividends
We know many investors are seeking income from their investments to meet a specific goal or fund their post-retirement needs. Dividends can play a role here. Interestingly, the 2013 Franklin Templeton Global Investor Sentiment Survey (GISS) revealed that more than half of the individuals surveyed globally believed they could meet their long-term goals without investing in stocks4. Given the current low yields of many traditional fixed income investments, I’m not so certain. We think the dividend story remains compelling.