Motley Fool Money - 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

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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 instill 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 percent 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 Molly Full 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. Maddie 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 dividends. 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 for investors and institutional money. And so we saw this massive rotation out of, you know, a large swath of the market into top tech companies, the Magnificent Seven, as we've come to call them, the Mag7.

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 reeds, for industrial companies, for small cap, midcap companies. And so you saw the yield, you know, 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 of shunning dividend stocks, it just feels like a little bit of a contrarian play to be. 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 a 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 when interest rates were in the teens. It always comes down in the long run to company fundamentals. What kind of competitive advantages does the 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, resilient. 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 leaves the 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 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? are you, and how do you think about investing in dividend payers versus growth of your 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 in two, Do dividend growers tend to have significantly lower volatility than companies who don't pay a dividend.

So not only do dividend grows circularly app reform, 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. Like if you look to three largest companies today, Apple, Microsoft, and Nvidia, Nvidia initiated dividend in 2012. And since that time, all three of those companies, which are all members of the Mag 7, they've had a dividend yield higher than the SP500'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. Antrimone. There you go. Yeah, so let's run with that for a bit. a company choose to pay a dividend in the first place? And 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, like 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

ways that they can allocate that capital. They can either reinvest in the business. They can make acquisitions. They can payback 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 of the company or reveal management's expectations for the future. And I think a lot more companies are issuing 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,

companies just make so much money and they have tens of billions of dollars sitting on their balance sheet and 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 too 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 in the ANSET and just put the opposite view on it. And that is, you know, know, 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, you know, small or newly public companies, they're still investing heavily to grow. You know, they, 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 Aunt 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 instill 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 percent 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, you know, hey, 20 or 30 percent 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 percent 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 Ant to chime in on this one as well. Well, 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 would give you a good idea as to how sustainable the dividend might be. For example, if you have a company that's paying consistently 90, 95 percent 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. And 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, Fastenol, 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 cash flow 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 growth, the dividend growth follows the earnings growth every 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, right? Because we just, we love dividend growth and we hate when a company is either, you know, 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, right, in 2020, it made sense for a company like Vail Resorts or a Ryman Hospitality Properties or a Simon Property Group to temporarily suspend their dividend because they were in the midst of a once-in-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, you know, for the hospitality industry, the entertainment, the retail industry. So that made sense at the time. And what you want to see is, okay, companies made a decision to cut or pause or suspend the dividend, but how fast can they bring it back? What are things 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 Riemann Hospitality Projects 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 companies like Intel VF Corp, I think is another one. So that tends to be a trend. And 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 really, 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 dividends 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 Poole'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, Poole 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 Poole 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 years, that the housing market's going to bounce back. There's going to be transactions there. That's going to probably, you know, re-ignite their business again.

And so they see the light at the end of the tunnel. And that's what's beautiful about companies like Poole 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 IPOed 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-grothy 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, you know, 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

draw down 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 bounce back and reach 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, you know, kind of understanding where, you know, 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, you know, undergarments, sweat-wicking undergarments back in the kind of early 2000s, Nike wasn't even, you know, 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, you know, 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, you know, 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 is going to, he's going to be replaced by Chipotle's Brian Nickel.

So Starbucks has paid a dividend in the past. What's Nichols' 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 see, 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 at dividend every year since 2010. It's kind of become a big part of the company's capital allocation. Will Nicol change that if he comes in and says, hey, I want to, you know, I want to

reach, 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. You know, I don't want to spend all this money that we're going out the window for the dividend. That is a question for me. And so, and it would, you know, 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 exacts 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, et cetera. Yeah, I think there's probably three reasons why Sartimproper 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 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 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 two, 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 raises 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. Reets are required to distribute at least 90% of their net income to shareholders through dividends. Do you evaluate REITs differently than you would non-reate dividend payers? A little bit. Yeah, I would say, because REITs by Lull, 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 rate 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 like to look for is a REITS 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 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 one I like in particular is the Schwab U.S. dividend equity ETF. The ticker S is SCHD. It's got a great track record. It's kind of focuses on larger dividend pairs 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 tend to follow is the Vanguard Dividend Appreciation ETF, the ticker is VIG. That is more 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 our key factors in our dividend investor service. Matt Argersinger, Anthony Chavone, our resident dividends. and 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.