Motley Fool Hidden Gems Investing - Dividends = Discipline

Episode Date: August 17, 2024

Right now, the S&P 500 is paying a paltry 1.3% dividend yield. The only time it’s been lower than that was during the dot-com boom. Matt Argesinger and Anthony Schiavone lead The Motley Fool’s Dividend Investor portfolio. They joined Mary Long for a conversation about: - Why companies pay dividends. - How to tell if a company’s payout is sustainable. - Dividend payers including Pool Corp, Nike, and Starbucks Companies/tickers mentioned: HSY, FAST, POOL, NKE, SPG, SBUX, CMG, SPG, SCHD Host: Mary Long Guests: Matt Argersinger, Anthony Schiavone Producer: Ricky Mulvey Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. I would just say, I think your aunt and I will agree on this, many more companies should be paying a dividend. There are far more benefits, even a small mid-cap company that might be in

still the third or fourth inning of its evolution. A dividend can instill a lot of discipline on management. If you think about it, if you have to pay out, say, 20 or 30% of your earnings every year for your dividend, if you've promised that to shareholders, it's going to have an effect on how you allocate capital. I'm Mary Long, and that's Matt Argersinger. He's a regular on Motley Fool Money. In his day job, Matt runs The Fool's dividend investor portfolio, along with Anthony Chavone. Dividend Investor is available to members of Epic and our advanced investing services. Mattie A and Ant joined me to check in on the dividend payers and why they've had a rough few years compared to the broader market, how dividends affect decisions in the C-suite,

and if Nike can write another comeback story. So I want to start by checking in on the status of dividend stocks as a group. Broadly, dividend ETFs have underperformed the S&P 500 year to date and also over the past five years. So with that intel up front, what's the long-term case for looking at dividend payers? Well, thanks, Mary. Thanks for having us. Yes, it's been a challenging five years for dividend. I would say really, especially in the immediate aftermath of the pandemic, you had this real strong rotation in the market to large cap, but especially large cap tech companies. And these companies, because of their balance sheets, because of their business models, the ability to thrive and prosper in a more online world, it galvanized just a lot of interest from investors and institutional money. And so we saw this massive rotation out of a large swath of the market into top tech companies, the Magnificent Seven, as we've come to call them, the Mag Seven.

And what it did was pretty extraordinary to the market. In fact, right now today, with the S&P 500 at or kind of near an all-time high, the dividend yield in the market is 1.3%, paltry. And it's actually the second lowest level in history. you have to go back to early 2000 at the peak of the dot-com boom for the yield on the S&P 500 to be as low as it is today. But if you look at what happened in the aftermath of the dot-com boom, dot-com crash, the subsequent years beyond that, there was a real resurgence in the enthusiasm for dividend paying stocks, for REITs, for industrial companies, for small cap, mid cap companies. And so you saw the yield, you saw yield become a much bigger factor for investors. For many years,

after the dot-com crash. Now, I'm not saying we're heading to some kind of tech crash today, but there are some parallels to today. And I would just say with the yield so low and really investors of all kinds kind of shunning dividend stocks, it just feels like a little bit of a contrarian play to be looking at dividend companies today. The macro story that's also played out over the past few years has been that of interest rates, right? Does that have an impact on how investors think about dividend stocks? What's the relationship between dividend payers and interest rates? Sure. In the short term, I would say absolutely. Interest rates kind of affect all asset classes. But yes, I think higher interest rates in the short term can be mostly a

negative for dividend stocks. Because if you think of it as the risk-free rate in the market goes higher, investors start asking themselves, well, if I can get 4% or 5% risk-free from treasury bills, from my bank CDs, from the money market account that's in my brokerage account. Why am I going to go out and buy a dividend stock yielding 3% or 4% and take on a lot of additional risk? And it's really the first time investors have faced that, frankly, in the market for a long time. But over time, the level of interest rates in the market doesn't really matter. If you go back to the 70s and 80s, dividend paying companies did really well. And that was a period where interest rates were in the teens. And so it always comes down in the

long run to company fundamentals. You know, what kind of competitive advantages does a company have? How resilient are its earnings? Does it have long-term pricing power? In the long run, these are the far more important factors than the level of interest rates. And I think with dividend stocks, you're really fishing in a pond with companies that generally have very good fundamentals, very good earnings, reliability, resiliency. I would say over time, no matter what interest rates do, finding good quality dividend paying companies will do really well. I think that's a good point because I think it's important for investors to keep in mind that even when interest rates are rising, that typically means that the economy is strong

and these companies are generating a lot of free cash flow, which likely means that they're increasing their dividends. And Matt, you mentioned the 70s and 80s when interest rates were super high. That was also a time when companies were increasing their dividends at a pretty high rate. So yes, interest rates impact asset prices, but higher interest rates also can signal that earnings growth is generally pretty strong, which leads to higher dividends over the long term. So there's a little bit of give and take there. And I want to stick with you because you are a younger investor. And typically, conventional wisdom would tell us, okay, when you're young, that's really the time to take this risk on approach and to invest and focus on

growthier stocks. So why are you putting your money into dividend payers? And how do you think about investing in dividend payers versus growthier stocks? Yeah, that's a good question. Our friend Matt Frankel once told me that, I'm in my 20s, but I invest like I'm in my 70s. So I'd like to think that's true because people in their 70s are a lot wiser. But there's a couple of reasons why I do like dividend-paying stocks. First is that we know that over the long-term, companies that regularly increase their dividend

tend to outperform stocks that either don't grow their dividend or simply don't pay a dividend. And then two, dividend growers tend to have significantly lower volatility than companies who don't pay a dividend. So not only do dividend growths certainly outperform, but they tend to do so with less risk or volatility. And then I also think there's this misconception that once a company decides to pay a dividend, its growth days are behind it.

I don't think that's true, really, at all. If you look at the three largest companies today, Apple, Microsoft, and NVIDIA, NVIDIA initiated a dividend in 2012. And since that time, all three of those companies, which are all members of the MAG7, they've had a dividend yield higher than the S&P 500's yield at some point. So even the growthiest of growth stocks were once stodgy dividend payers with above market yields. So I think if you're a younger investor like myself, you don't need to necessarily invest in dividend paying stocks, but at least don't discard them simply on the basis that they

can no longer grow at a high rate. Spoken like a true 70-year-old. There you go. Yeah. So let's run with that for a bit. Why does a company choose to pay a dividend in the first place? Ant, you hit on this idea that typically it's only the stodgy companies that are paying dividends where their growth days are over. But as we've seen recently, a lot of large tech companies have chosen to implement dividends. Why is that? Yeah. So when a company generates free cash flow, there's a couple of ways that they can allocate that capital. They can either reinvest in the business, they can make acquisitions, they can pay back debt, repurchase shares, or the last one,

which we like, they can pay a dividend. And a company might pay a dividend to attract new investors to buy the stock or keep existing investors into the stock, maybe to show financial strength to the company or reveal management's expectations for the future. And I think a lot more companies are initiating a dividend, particularly tech companies, because one, their stock's relatively expensive right now. Not all stocks, but some of them are. So buybacks might not make the most sense right now. And then secondly, these companies just make so much money and they have tens of billions of dollars sitting on their balance sheet in cash. So they really don't have a better use for it. So maybe the best use is the return to shareholders

through a dividend. You two run our dividend investor service. So I know that you are looking for companies that pay a dividend, but are there any types of companies that should not pay a dividend that that does not make sense for and that you wouldn't want to see that tactic? Yeah, that's a good question. I mean, you could just take everything that Ann said and just put the opposite view on it. And that is, companies that don't have good earnings visibility, don't have good fundamentals, have a weak balance sheet, or they just don't have the cash need to pay the dividend, or the dividend just far exceeds the free cash flow that the company is generating. And you'll see this with a lot of small companies, small or newly public

companies, they're still investing heavily to grow. In most cases, or a lot of cases, they're not generating any profits. And they probably shouldn't be paying a dividend because there's a lot of smarter or more critical capital allocation decisions that need to be made versus a much larger company, as Ant mentioned, like an Alphabet, which has just tremendous billions of dollars of cash on their balance sheet, tons of earnings visibility. In my view, should have been paying a dividend 10 years ago, but I'm glad they initiated one this year, finally. But yeah, so there is a case, there is a situation where companies shouldn't pay a dividend. I would just say, I think your aunt and I will agree on this, many more companies should be paying a

dividend. There are far more benefits, even a small mid-cap company that might be in still the third or fourth inning of its evolution. A dividend can instill a lot of discipline on management. If you think about it, if you have to pay out, say 20 or 30% of your earnings every year for your dividend, if you've promised that to shareholders, it's going to have an effect on how you allocate capital, knowing that, hey, 20 or 30% of my earnings aren't going to be available to me to invest. And so I've got to be more disciplined with the 60% or 70% that I have available to invest. And so I love when I see smaller companies initiate a dividend. It's a good signal that there's probably positive things going on there and certainly a brighter future.

Just because a company pays out a dividend doesn't necessarily mean that it's a great investment idea. So what do you look at to determine if a dividend is actually healthy? And how do you tell the difference between a dividend that's too high or maybe not high enough? And Matt, it's like one of those companies that you mentioned where you're saying, you should have done this years ago. You should have raised this before. Right. Well, I'd love Anne to chime in on this one as well. I mean, the standard thing that we tend to look at, a lot of investors look at is the payout ratio, which is just the percentage of earnings that are being paid out as the dividend. That'll give you a good idea as to

how sustainable the dividend might be. For example, if you have a company that's paying 90%, consistently 90, 95% of its earnings out as dividends, any kind of earnings setback or a slow phase for the business could put that dividend in peril, but we're not necessarily afraid of high payout ratios. It really comes down more to the trajectory of the earnings. If you want to have a company that you know is, even if it's a seasonal or a cyclical business, a business has this type of earnings power and can grow its earnings at 5%, 10%, 15% per year, say over the next several years, even if the payout ratio is high, 70%, 80%, you have confidence that they're going to earn enough to more than cover the dividend and still have money left over to

either grow it or reinvest back in the business. And so I think the key factor, look at payout ratios, but also focus on where you think earnings per share are going. And that's going to tell you a lot about what the dividend can do. Ant, you got anything to add there? No. I mean, I would just echo Matt's thoughts about not being scared of a higher payout ratio, because there are companies like Hershey is one company, Fastenal, which is a distributor, is another company where they typically have payout ratios higher than 50%, sometimes around 60% or even higher than that, but they consistently increase their dividends year over year at a high rate because they're such consistent businesses and they generate

so much cashflow that they can afford to pay out a higher percentage of their earnings. So don't be afraid of high payout ratios, but just make sure that the business is a consistent cash generator and they're still raising their dividend at a high rate because the earnings the earnings growth, the dividend growth follows the earnings growth over time. So focus on that. I know another thing that you both keep an eye out for is reliable dividend growth. So with that in mind, when might you be okay with a company not pursuing that kind of growth, either pausing or stopping or decreasing their dividend, but that's not necessarily a red flag for you? Well, it's almost always a red flag, Mary, because we love dividend growth and

we hate when a company is either pausing that growth or worse, cutting its dividend or even suspending the dividend. But there are certainly exceptions. I mean, if we look at the pandemic in 2020, it made sense for a company like Vail Resorts or Ryman Hospitality Properties or Simon Property Group to temporarily suspend their dividend because they were in the midst of a once-in-a-generation macro event that was completely out of management's control. and they had no visibility as to when things were going to get better for the hospitality industry, the entertainment, the retail industry. So that made sense at the time. And what you want to see is, okay, the company's made a decision to cut or pause or suspend the dividend, but how fast can

they bring it back? What are things that they can do in their control to make sure that earnings stay resilient, the balance sheet's protected? And so that when the macro situation clears up, when the pandemic is sort of waning, can they bring back the dividend? And you saw companies like Vail Resorts and Ryman Hospitality Products bring back their dividend pretty fast as soon as there's more visibility around the pandemic. So there are instances always, it's got to be out of management's control. If it's in management's control and they cut the dividend, that's usually always a red flag for us. And typically when that happens, Matt, when a company cuts their dividend and it's in management's control, usually another dividend cut would follow that. We've seen that

with a couple of companies like Intel, VF Corp, I think is another one. So, that tends to be a trend. Companies who tend to cut their dividends tend to not perform well moving forward. Yeah. It's hard to reverse that negative momentum once it comes in. And it's almost always, as we've seen, it's almost always a bad signal ahead. So, we're going to switch gears here. We've spent a lot of the show thus far talking about the basics of dividend investing and kind of how dividend stocks are faring in this current moment. And we're going to instead spotlight some more specific companies for the rest of the show. So I'll kick things off because one thing that one dividend payer that has caught my eye recently

is Pool Corp. As the name suggests, it distributes swimming pool related products. You zoom out over 10 years, and this is a company with a really great track record, But it hasn't fared so well in more recent years, in large part because of this interest rate story that we mentioned earlier, and the fact that because of the higher interest rates, home improvement projects have been put on the back burner. But from this dividend perspective, this is a company that's paid a dividend since 2013, I think, and been reliably raising that dividend since. So okay, stock's not faring so great now.

Sales have been down comparably, but what's not to like? I don't know that the long-term story is no longer intact. Yeah, I love the question. What's not to like? First of all, I love the name, Pool Corp. It tells you exactly what the company does, which I wish there were more companies like that. But Pool Corp is a great example of what we've been talking about in the show, which is there

can be businesses where they're cyclical, they're seasonal, in Pool's case, both, but they're also in the midst of this higher interest rate phase where, yes, homeowners are spending less on big projects like pools or pool renovations. And that's kind of hit their business lately. But at the same time, pool raised their dividend a few months ago. And as you mentioned, Mary, they've been raising it for over a decade. And I think that speaks to the fact that pool is a business because of their leading market share in the industry, because they have good earnings visibility, because they've been through down cycles in the past and know how they generally come out of them. They know that, for example, when mortgage rates fall, probably in the next

couple of years that the housing market is going to bounce back. There's going to be transactions there. That's going to probably reignite their business again. And so they see the light at the end of the tunnel. And that's what's beautiful about companies like Pool that have a lot of visibility. They can see through the clouds like a lot of companies can't. And so I think it makes total sense that they're raising their dividend and it's a sign of just how strong their business is. Nike is another one that we were kind of kicking around before the show. That is a company that's consistently paid dividends since 1986 and has raised those dividends since 1997, the company IPO'd in 1980. So it got on the dividend train pretty early on, which again,

kind of contradicts this idea that we were talking about earlier that only mature non-growthy companies pay a dividend. All that said, business has run into some challenges lately. Sluggish sales growth the past couple of years, supply chain issues, greater competitions from smaller sneaker companies. Management has said recently that it wants to quote, reignite growth. So I mean, again, we've talked about mature versus growth, all these different ideas and how that plays into the dividend conversation. Where are your heads at when you think about Nike right now and the state of their dividend? Yeah. Nike is one that Ant and I have been talking about, kind of going back and forth on. And it's just remarkable to see a company like

Nike, it's right in the middle of its third biggest drawdown in its history as a public company. I think the stock is still down roughly 60% from its all-time high, which is just, again, it's only happened three times in Nike's history, but it's always bounced back. It's always bounced back and reached new all-time highs. And that's kind of why we're interested in it. What is Nike doing to get back on the mountaintop, so to speak? It definitely feels like an opportunity. I would say with Nike, the business has always been about fashion being fashion forward, understanding where athletes are going, but not just athletes, where styles are going. And Nike hasn't always been first to those markets, but it usually is great at getting into

those markets. If you think about when Under Armour first came out with sweat-wicking undergarments back in the early 2000s, Nike wasn't even a small part of that market. And eventually 10 years later, it has a huge market share in that business. It's been slow to get into certain basketball shoe lines or running shoe lines, but it's always kind of followed on with better products. I think our biggest concern with Nike right now, or at least my biggest concern is I'm not that confident in management. And based on the CEO and the history there, I'm thinking they might need a new leader. But I do think the dividend is relatively safe. It's a relatively small part of Nike's earnings. I think they want to keep that growth track record intact. It might not grow as

much as it has in the past, but dividend is not something I'm worried about with Nike. It's more about the overall trajectory of the business. Another company facing some uncertainty and a new leader is Starbucks, which was in the news a lot earlier this week when the CEO was ousted and he's going to be replaced by Chipotle's Brian Nicol. So Starbucks has paid a dividend in the past. What's Nicol's relationships with dividends been historically? And might we see that change as he comes to the front of this company? Right. As a Starbucks shareholder, I have to say I'm a little worried about the dividend, only because if you look at Brian Nichols' history with Chipotle, Chipotle's never paid a dividend. It certainly didn't during Brian Nichols' leadership there.

Whereas Starbucks, as you mentioned, it's paid a dividend. It's grown its dividend every year since 2010. It's become a big part of the company's capital allocation. Will Nichols change that if he comes in and says, hey, I want to change the company's capital allocation strategy. I want to reinvest in this part of the business. I want to protect the balance sheet. I don't want to spend all this money that's going out the window for the dividend? That is a question for me. And it would, if that dividend was cut or were suspended or removed, it would certainly sour my opinion a little bit about Starbucks, because I think the dividend is a firm part of the business. It enacts exact discipline on management, and I'd like to see it be maintained.

And I know you're a big fan of Simon Property Group. This is a REIT that owns shopping, dining, and entertainment properties around the world. This year, Simon's increased its dividend twice. How has Simon Property Group been able to strengthen its business, increase its dividend, despite having faced so many obstacles over really the past two decades from the Great Recession, to the e-commerce coming for malls, to COVID, interest rates, etc.? Yeah, I think there's probably three reasons why Simon Property Group has been able to weather those headwinds. I think they're a quality management team. They have a strong balance sheet. And then the third one is high asset quality. So if you look at the management team,

David Simon, he's been the CEO at Simon Property Group. I mean, the company's named after him for about 30 years. So when those headwinds emerged roughly, call it 15 years ago, he already had 15 years of experience under his belt. So Simon already knew the importance of having a strong balance sheet and the importance of owning high quality real estate in the best locations. So I think that's super important. So over the last decade, Simon has barely taken on any incremental debt or new equity to fund its business, which is very unusual for REIT, especially during a difficult time. And now that the operating fundamentals for the business are starting to improve, I think management's actions that they took in the prior decade

has really set Simon up to perform well in the future. Because if you look at their performance today, occupancy is nearly 96%, which is in line and actually slightly higher than pre-pandemic levels. And you have to think about too, they're replacing lower quality tenants with higher quality tenants. So that tenant roster today is also stronger. And then finally, you mentioned that Simon already raised his dividend twice this year, but they also increased the dividend six of the last eight quarters. So despite all the negative headlines about the death of the shopping mall. Simon's business is performing very well. And high quality malls, I don't think are going anywhere anytime soon. REITs are required to distribute at least 90% of their net income

to shareholders through dividends. Do you evaluate REITs differently than you would non-REIT dividend payers? A little bit. Yeah, I would say because REITs by law, they can't retain a lot of their cash flow to reinvest for growth. So they're typically forced to either issue debt or equity to develop or acquire properties. So the quality of the management team and the quality of their capital allocation is extremely important. So typically, the first thing that I do when looking at a new REIT is to read the proxy statement and see what management's incentives are. Are they being incentivized to grow cash flow on a per share basis? And are they incentivized to maintain a strong balance sheet? And then,

are those incentives being reflected into the financials? So one thing I look for is a REIT's dividend growth? Is a dividend growing faster than growth in total debt and shares outstanding? I think that's one way to gauge if a management team is allocating capital effectively. We've talked about a few different dividend payers throughout the show, but there are also dividend ETFs and index funds. Is there a case to be made for looking at those rather than jumping into individual companies? Absolutely, Mary. I think if you're someone who's interested in allocating more of your portfolio to dividend paying companies, but you're not certain you're going to be able to pick the best dividend paying companies out there for sure.

There are some great options these days. I mean, you have one I like in particular is the Schwab U.S. Dividend Equity ETF. The ticker S is S-C-H-D. It's got a great track record. It kind of focuses on larger dividend payers that can grow their dividends over time. One of my retirement IRAs is loaded up with Schwab U.S. Dividend ETF. And then I would say another one that also Antonin and I tend to follow is the Vanguard Dividend Appreciation ETF. The ticker is VIG. That is more growth or dividend growth oriented. So companies that might have smaller yields, but are growing their dividends outsized rates. So that's one we pay attention to because dividend growth is one of the sort of key factors in our dividend investor service.

Matt Argersinger, Anthony Chavone, our resident dividend royalty. Thanks both so much for the time and for joining us today. Thank you, Mary. Thank you. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow. Thank you.