Alliance Portfoliopractice-dividend-stocks Jan 2011

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PortfolioPractice: Academy

Dividend stocks – an

attractive addition to aportfolio

In the last 40 years dividends contributedroughly one-third to the overall, annualisedreturns of equity investments.

January 2011

In forma t ion for f und d i s tr i b u

tor s

and in s t i t u t iona l in ve

s tor s. No t for

c irc u la t ion to pr i va te

in ve s tor s.




2

Decisive Insightsfor forward-looking investmentstrategies



3


Content

4 Dividend stocks – an attractiveaddition to a portfolio

5 Dividend yields different from

region to region

7 Dividends – an underestimatedperformance driver

8 How sustainable are dividends?

10 Dividend stocks – a safe haven?

13 Conclusion

Imprint

Allianz Global Investors

Kapitalanlagegesellschaft mbH

Mainzer Landstraße 11–13

60329 Frankfurt am Main

Capital Market Analysis

Hans-Jörg Naumer (hjn),

Dennis Nacken (dn),

Stefan Scheurer (st),

Richard Wolf (rw),

Lars Düser (ld)

Data origin – if not otherwise noted:

Thomson Financial Datastream.




4

Dividend stocks – anattractive addition to a

portfolio

The equity markets performed well in 2010. Numerouscompanies registered record profits, so investors have goodreason to expect higher dividends this year. Dividend stocksappear to be an attractive addition to a portfolio, particularlyin the current low-rate environment. Will the higher dividend

payments be sustainable? And what do investments in divi-dend stocks offer at the moment?

In the current market environment a

strategy based mainly on dividends appears

attractive. While the average dividend return

for European companies (which pay out a

large share of their profits in an international

comparison) fell from more than 3.5 % in

mid-2010 to roughly 3.2 % at the end of 2010across the market (basis: MSCI Europe) due to

the stock-market year-end rally, it is still high

in an international comparison. Moreover,

Summa Oeconomica

•Bond-market yields are comparatively low at the moment. In this capital-market

environment dividend stocks appear to be an attractive addition to fixed-income

investments.•In an international comparison, European and Australian companies are particularly

generous and pay out much of their profits to the investors. US companies tend to prefer

a more flexible payout vehicle, namely share buybacks.

•A look at the past shows that dividends are a key factor for a successful equity investment.

Dividends contributed roughly one-third to the overall, annualised returns of equity

investments in the MSCI Europe between 1970 and the end of 2010.

•Dividend payouts tend to be steadier than corporate profits. As a result, shareholders

receive annual revenues from dividend payments. These revenues are relatively reliable,

and investors can do what they want with them.

•Stocks with high dividend returns have tended to be less volatile.

•In view of currently low dividend payout ratios – in the US, the ratio has even dropped to itslowest level in 40 years – and the favourable profit developments in 2010 companies have

room for further dividend increases in the future.

this is only an average figure. With a dividend

strategy focusing mainly on a portfolio of high

yielding stocks, anticipated dividend earnings

can be boosted. According to estimates by

data provider Thomson Reuters Institutional

Brokers’ Estimate System (IBES), 25 out of

the 463 companies listed in the MSCI Europewill probably pay no dividend at all for 2010.

In contrast, more than 120 index companies

offered dividend returns of more than 4 % at

Dividend yields

Focusing on high-dividend

stocks can considerably

boost the dividend yields

of a given portfolio



5

Chart 1: Dividend earnings of European equities are at an attractive level

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20101.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

Dividend yield MSCI Europe Yield 10-y. German government bonds Dividend yield MSCI Utilities

Past performance is not an indication of future results; Source: Datastream; Illustration: Allianz Global Investors Capital

Market Analysis

the end of 2010. For example, the average

dividend yield of European utilities companies

amounted to more than 4.5 % at the end of

2010. That means that European companies’

dividend payments often clearly exceed

10 year German government bond yields

(2.9 % at the end of 2010; chart 1). Moreover,

price and duration risks of bonds should notbe underestimated, particularly not in the

current low-rate environment.

If companies stick to their dividend policies

and stock prices do not move much, equities

offer a handsome “coupon”.

Dividend yields different fromregion to region

While investors in European equities can

currently enjoy high dividend yields, US

companies are less generous at first sight.

Dividend yields calculated on the basis of

2010 estimates for the Standard & Poor’s

500 (S&P 500) amount to only about 2.0 %

at the moment. Again, focusing investments

on high-dividend stocks helps to boost

anticipated yields considerably. While 123

companies listed in the S&P 500 did not pay

dividends at all, roughly 50 companies paiddividends worth more than 4 % of their market

capitalisation. Moreover, US companies are

much more interested in share buybacks than

their European counterparts; this instrument

is becoming increasingly popular. In 2010, a

total of 490 billion (bn) US-Dollar (USD) was

spent on buying back shares – an increase

of 23 % year over year and more than double

the amount spent in 2009. In 2006, total

dividend payments amounted to only USD

240 bn. Including share buybacks, whichmay be regarded as an indirect payout to

shareholders, the total payout ratio (dividends

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Dividend yield Yield of share buybacks Total yield

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Chart 2: Share buybacks are becoming an increasingly important

payout vehicle for US companies

Source: Standard & Poor‘s; Illustration: Allianz Global Investors Capital Market Analysis




6

Past performance is not an indication of future results; Source: Datastream; Illustration: Allianz Global Investors Capital

Market Analysis

Chart 3: Low interest level is one reason for low dividend yields in Japan

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Yield 10y Japanesegovernment bonds Dividend yieldMSCI Japan Dividend yieldMSCI Pacific ex Japan

In Japan, direct investor participation in a

company’s success via earnings distributions

is smallest. The dividend yield of the MSCI

Japan amounts only to about 1.9 %. Almost all

companies show their good faith and pay out

at least a small share of overall earnings; only

4 members of the MSCI Japan are unlikely topay a dividend for 2010. However, only for

ten companies does the dividend yield come

in at more than 4 %. Here, too, companies

enter into share buybacks to a larger extent.

At the same time the overall yield level is

considerably lower in Japan’s deflationary

environment. In fact, the “low” dividend yields

are still above the average yield of Japanese

bonds (see chart 3).

A look beyond Japan shows that not allcompanies in Asia have closed their pockets;

some of them are quite generous. Investors

who put their money in the Asia-Pacific

region can hope for an average dividend yield

of 3.2 % (basis: MSCI Pacific ex Japan). Roughly

one out of three index members will probably

pay a dividend of more than 4 % of the stock

price registered at the end of 2010 for the

financial year 2010. Australian companies in

particular are generous and pay out much of

their earnings to shareholders.

+ share buybacks) of US companies rises

to an impressive 5.1 % (source: Standard

& Poor’s; see chart 2). A lower number of

outstanding shares tends to push up share

prices and the earnings per share. However,

share buybacks are more volatile and thus

less reliable than dividend payments. As a

more flexible liquidity-steering tool, they aremore closely correlated with the more volatile

earnings performance.



7

Dividends – an underestimatedperformance driver

A glance at past performance – with the

proviso of course that this may change

in future – illustrates the performance

contribution of dividends: If an investor

had made a single investment of 100 euros

in stocks of the MSCI Europe in 1970 and

reinvested the dividend payments annually,he would have had 5.126 euros at his disposal

(before tax) at the end of 2010 – despite

the financial crisis. Without the effect of

the annually reinvested dividends, i. e. if we

consider the “pure“ share price performance,

the portfolio would have grown to only 1,169

euros (see chart 4). The bottom line is that

a good 40 % of the total annualised earnings

of the equity investment over this period

amounting to 10 % was accounted for by the

dividend payments!

In particular, investors in European stocks

enjoyed high dividend payments in the past.

Performance contribution of dividends

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 100

1000

2000

3000

4000

5000

6000

7000

MSCI Europe - Total return index MSCI Europe - Price index

Chart 4: Dividends account for much of the performance

Past performance is not an indication of future results; Source: Datastream; Illustration: Allianz Global Investors Capital Market Analysis

European companies pursued a shareholder-

friendly payout policy during the past few

years. On average, dividends have contributed

about 4.1 % to the overall performance of

the MSCI Europe since 1970. While the price

performance on the North American equity

market was comparable during this period

(6.4 % p. a., excluding dividends), dividend

payments contributed less to the overall

performance (3.6 % p. a.). Companies in thePacific region (in particular in Japan) were

least generous, which is why the dividend

contribution to overall performance was the

lowest world-wide during the past 40 years

(only 2.2 % p. a.; see chart 5).

There appear to be two key questions for

investors seeking information on the future

success of dividend strategies:

• How sustained will dividend earnings be in

the current market environment?• And what advantages can dividend

strategies offer long-term investors?




8

How sustainable are dividends?

To separate the wheat from the chaff,

therefore, investors need to undertake

a fundamental sustainability analysis,

considering among other things the degree

of profitability and dividend continuity of acompany.

Three factors which hint at stable dividend

earnings in the current market environment

are:

1. The basis for dividend payments, group

profits, probably rose markedly in 2010. In

fact, some companies already announced

new record gains. According to analysts’

estimates used by the data providerIBES, European companies (basis: MSCI

Europe) will have seen their profits rise

by some 35 % in 2009. While the earnings

momentum looks set to weaken in 2011,

further increases are likely.

2. The favourable earnings development

in 2010 is one reason why the dividend

payout ratios were recently down markedly.

A look at the current dividend policies of

Chart 5: Dividend policies most shareholder-friendly in Europe

Performance contribution of dividends and share prices 1970 till 2010 in global

comparison (annualised).

Past performance is not an indication of future results; Source: Datastream; Illustration: Al-

lianz Global Investors Capital Market Analysis

6.4%5.9%

4.1%

4.1 % 3.6 %

2.2%

0 %

2 %

4 %

6 %

8 %

10 %

12 %

MSCI Europe MSCI North America MSCI Pacific

Performance contributionof share prices (p. a.)

Performance contributionof dividends (p. a.)

25 %

30 %

35 %

40 %

45 %

50 %

55 %

60 %

65 %

70 %

75 %

80 %

Payout ratio of European companies (MSCI Europe) Payout ratio of US companies (MSCI USA)70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Chart 6: Low dividend payout ratios offer room for further dividend increases

Dividend payout ratio (dividends/earnings) between 1970 and 2010.

Source: Datastream; Illustration: Allianz Global Investors Capital Market Analysis



9

international groups shows that, in Europe,

the ratio of dividend payouts and earnings

per share is currently moderate in a

historical comparison, at about 45 %. In the

US, the ratio has even dropped to its lowest

level in 40 years (about 30 %; see chart 6).

Companies therefore have room for futuredividend increases.

3. Companies currently have large amounts

of money at their disposal (free cash flow).

As the deleveraging process has made

considerable progress after the financial

crisis and companies have improved their

capital base and reduced their leverage,

companies might increasingly focus onshareholder value once again (chart 7).

Chart 7: US companies have large amounts of cash at their disposal

US companies have large amounts of cash at their disposal

Past performance is not an indication of future results. Source: Datastream; Illustration: Allianz Global Investors Capital

Market Analysis

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 100.05%

0.06%

0.07%

0.08%

0.09%

0.10%

0.11%

0.12%

Net cashflows of US companies / US GDP (real)




10

However, there are some factors which argue

against a market-wide increase in dividend

yields:

1. Historical experience has shown that, after

financial-market crises, recoveries tendto be relatively weak and a self-sustaining

upswing is slow to emerge. This supports

the view that the pace of growth will slow

in 2011 after a strong catch-up effect in

2010. Growth looks set to be moderate and

below potential.

2. There are still many companies whose

profits are volatile, for example banks,

which are hard pressed to guarantee

dividend continuity in the face of highrefinancing needs and increasing

regulation.

3. Instead of distributing the free cash flow,

companies might search for investment

opportunities and resume merger activities.

Overall, however, dividends for 2010 will

probably be raised; in fact, some companies

have already announced increases.

Dividend stocks – a safe haven?

Another advantage for investors in high-

dividend stocks is that dividend payments

tend to be steadier than corporate profits. A

comparison of dividend payments and profitsof the companies listed in the MSCI Europe

shows that corporate profits were much more

volatile during the past 30 years (see chart

8). One reason is that the dividend policy is

often a key part of the corporate strategy.

Companies therefore aim at securing steady

dividend payments. As a result, shareholders

receive annual revenues from dividend

payments. These revenues are relatively

reliable, and investors can do what they want

with them each year.

Not only are earnings distributions less volatile,

but also have dividend stocks tended to be

subject to smaller price movements than the

overall market in the past. One possible reason

for lower price volatility is that companies with

high dividend yields offer investors regular

revenues and, in turn, more security. Moreover,

companies with a solid dividend history are

often assumed to have a solid earnings history,

10

Regular revenues

Dividends offer

shareholders regular

revenues, which are

comparatively reliable.

0

200

400

600

800

1000

1200

1400

1600

1800

2000

MSCI Europe: Development of dividends (indexed) MSCI Europe: Development of corporate profits (indexed)

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Chart 8: Dividends are steadier than corporate profits

Source: Datastream, Illustration: Capital Market Analysis Allianz Global Investors



11

Selection criteria for the Dow Jones “Select Dividend” index

family:

Companies

1. whose net dividend returns are among the TOP 30 or TOP 100 of

the relevant market index,

2. which have not reduced their dividend payments at any timeduring the past 5 years, and

3. whose dividend ratio is below 60 %.

While the “U. S. Select Dividend Index” covers the 100 US equities

with the highest dividends and was first calculated in 1992, the

“EURO STOXX Select Dividend 30” and the “Asia/Pacific Select

Dividend 30” indices include the 30 equities with the highest

dividend yields in the relevant regions. The history for these two

indices goes back to 1999.

too. The Dow Jones “Select Dividend” index

family (which is based on the stocks with the

highest dividends taken from broad market

indices for a given region) is a good illustration

of the risk-return profile of a dividend strategy

in comparison to the overall market.

The charts 9-11 show that an investment

strategy based on high-dividend stocks

usually paid off for investors during the last

few years, particularly in the euro area. While

the broad equity market was up only 1.6 %

p. a. since the end of 1998, investors in the

“Dow Jones Euro Stoxx Select Dividend 30”

would have obtained an annualised return

of 9.5 % – despite the bursting of the dotcom

bubble and the recent financial crisis. It is

interesting to note that the higher returnsof high-dividend stocks compared to the

overall market were achieved at the same

risks, measured against the market price

fluctuations (see chart 9).

High-dividend stocks

In the past high-dividend

stocks were less volatile

than the overall market.

High-dividend US stocks have also

outperformed since the launch of the Dow

Jones U. S. Select Dividend Index in 1992,

achieving a return of 12.3 % p. a. vs 11.0 % p. a.

for the overall US market. However, the

dividend strategy entailed somewhat higher

price fluctuations (see chart 10).




12

Only in Asia/Pacific did dividend strategies

underperform the overall market. Here,

growth stocks did better overall – and these

equities usually do not belong to the high-

dividend segment. Still, the lower volatility of

the Dow Jones Asia-Pacific Select Dividend

30 in comparison to the broader Dow Jones

Asia-Pacific (20.4 % p. a. vs 23 % p. a.) suggests

that a dividend strategy in this region is

nevertheless attractive from a risk-return

perspective (see chart 11).

Moreover, dividend payments are not yet

included in the analysis. Including above-

average dividend payments, dividend stocks

outperform the relevant broad market indices

even more palpably. While this statement is

somewhat unreliable in view of the relatively

short index histories, the result is surprisingly

clear – even taking into account that data

from the past are no guarantee of future

developments.

The search for dividend earnings carries risks,

however, and should not be observed in an

entirely uncritical manner. When buying

shares, dividend earnings can sometimes

give the wrong signals. It is assumed that the

current payments will remain stable in future,but that is not always the case. For example,

until the middle of 2007 financial stocks were

paying glittering dividends. But the onset of

the financial crisis brought huge falls in share

prices – and company profits and dividend

payments crashed with them.

Chart 9: Dividend strategies with

attractive risk-return profiles

Risk-return profile of a European dividend strategy in

comparison to the overall market (from 1998 to 2010).



Risk-return profile of a US dividend strategy in

comparison to the overall market (from 1991 to 2010).

Past performance is not an indication of future results;

Source: Datastream; Illustration: Allianz Global Investors





9.5%

19.7%

1.6%

19.8%

0 %

5 %

10 %

15 %

20 %

25 %

Performance p. a. Risk p. a.

DJ Euro STOXX Sel. Dividend 30 DJ Euro STOXX

12.3%

15.9%

11.0 %

15.5 %

0 %

2 %

4 %

6 %

8 %

10 %

12 %

14 %

16 %

18 %

DJ U.S. Select Dividend Index DJ U.S. Price-Index




13



Risk-return profile of a Asian dividend strategy in com-

parison to the overall market (from 1998 to 2010).




9.0%

20.4%

10.4 %

23.0%

0 %

5 %

10 %

15 %

20 %

25 %


DJ Asia Pacific Sel.Dividend 30 - Price-Index

DJ Asia Pacific -Price-Index

Conclusion

The additional revenue stream from earnings

distributions is not the only way in which

dividend equities can offer added value for

the portfolio in the long run. A fundamental

dividend strategy, under which equities are

selected not on the basis of recently paid, but

future, expected dividends, will permit to earn

handsome dividend yields despite the price

increases of the last few months. This strategyappears to be a promising addition to the

equity portfolio, especially in the current low

interest environment.

Dennis Nacken




14

Do you know the other publications of CapitalMarket Analysis – the investment think tank?

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→ From emerging markets to growth markets

→ Brazil: Local Hero – Global Winner

→ Asia on the move – gravitational centre of the 21st

century?

→ The sixth Kondratieff – long waves of prosperity

→ Focus: Eco-Trends

→ Outsmart yourself

→ Investing in Scarce Resources

→ Agricultural trends: Seed for growing a portfolio

→ Global investments in a globalised world

→ Demography: a global trend

→ Scarce Resources

→ The Right Way to Invest in the New Normal – 10 Theses

→ After 30 years, all good things...

→ China in 2011 – characterized by growth and change

PortfolioPractice

→ Sustainable – Responsible – Themed strategies

→ The new Zoology of Investment Risk Management

→ Is small beautiful?

→ Investing in Bonds and Equities

→ Focus: The Omega Factor

→ Portfolio Optimisation in Practice

→ Focus: Dividend strategies

→ Active Management

→ Black Swan

→ Sustainable Investing: just a fad?

You can find all the latest publications and podcasts of Capital Market Analysis under:

www.allianzgi.de/capitalmarketanalysis

http://www.allianzglobalinvestors.de/kapitalmarktanalyse/publikationen/Analysen-und-Trends-Knappe-Resourcen.pdf




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Kapitalanlagegesellschaft mbH

Mainzer Landstraße 11–1360329 Frankfurt am Main J

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