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Morningstar Dividend Guy: Two Stocks to Love, Two to Hate

A steady, healthy dose of income is the most obvious attraction of stocks with big dividends, but it’s not the only one. Advocates contend that companies that make dividends a high priority are often run more effectively than others because the payment obligation instills good habits in management. The ups and downs in earnings experienced by companies in cyclical industries can make it all the more difficult to achieve the discipline necessary to carry out a sound dividend policy, but it can be all the more impressive when they get it right. Josh Peters, editor of the Dividend Investor newsletter published by Morningstar, offers two examples of companies that have successful dividend policies and two that don’t.

One of his favorite high-yield stocks is Emerson Electric (EMR). The engineering and industrial conglomerate has raised its dividend in each of the last 56 years, Peters pointed out. At Friday’s close, the stock had a 3% dividend yield. Emerson “is a really good example of how dividends can work in a cyclical industry,” he said. “Over the long run, it’s had a pretty solid dividend growth rate.” The chart below highlights the commitment to strong and growing payouts by Emerson’s management. Free cash flow, which provides the wherewithal to pay dividends, has been all over the place during the tumultuous last five years, but dividends have risen 108% over the past decade.

 Chart

data by YCharts

A company that just had one tumultuous day is Intel. The stock (INTC) fell 6.3% on Friday, mainly due to weak revenue guidance and a warning that capital spending would be higher than expected, but Peters maintained that Intel is “among the tech sector companies that have done the best job on dividend policy.” As he sees it, Intel has created an optimum formula for allocating earnings. “They generate a huge amount of cash,” he said. “They invest hugely in the business, but they still have a lot left over for dividends and also repurchases and acquisitions. They want to reward shareholders directly.” The dividend yield is about 4%. One sign that Intel is looking out for its investors is that while its share price has been range-bound for a decade, its yield has risen consistently.

 Chart

data by YCharts

Peters offers no such praise for two other tech stalwarts, Microsoft (MSFT) and Hewlett-Packard (HPQ). If they had made dividend payments a bigger priority, he believes, shareholders would have been rewarded with higher dividend yields and fewer dumb mistakes by wayward executives. “At Microsoft they make acquisitions, then they write them off and let cash pile up on the balance sheet,” he observed. “They’re not creating value for shareholders. If Microsoft had the same approach to dividends as Intel, it would yield 5% or 6% and it wouldn’t affect their ability to manage the business.” As it is, Microsoft yields 3.4%, so it could be worse. For instance, it could be Hewlett-Packard. The chart below shows that Microsoft consistently pays out less of its earnings as dividends than Intel or Emerson and that H-P pays out far less even than Microsoft.

 Chart

data by YCharts

A series of poor decisions over the years at H-P -- beginning with the 2000 purchase of the personal-computer maker Compaq, just in time for a range of innovations that made PCs increasingly less relevant – destroyed value. The erosion has been so great, in fact, that the stock trades about where it did in the mid-1990s. Peters doesn’t blame all of that on a poor dividend policy, of course, but a better one, in his opinion, would have limited the bosses’ ability to mess up.

“Capital allocation has been a big problem,” he said. Highlighting the company’s “token dividend payment,” which gives it a 3.1% yield, mainly due to the weak share price, Peters remarked that “a bigger dividend would have imposed more discipline on management. When a company steps up and makes a serious commitment to dividend payments, it’s going to cramp their style and make them less likely to do empire building.”

Conrad de Aenlle, a contributing editor at YCharts, has covered investment and personal-finance topics for more than 20 years, writing for The New York Times, International Herald Tribune, Los Angeles Times, Bloomberg News, Institutional Investor, MarketWatch and CBS MoneyWatch. He can be reached at editor@ycharts.com.

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