Dividend stocks and dividend mutual funds are very popular right now among everyone else as well. After the tech bubble burst and the subprime crisis took a big chunk out of people’s portfolios, lots of investors were shell-shocked. Now all they want is nice steady, unspectacular gains. The siren song of the dividend stock is very alluring. The Coca-Cola Company (NYSE:KO) The Procter & Gamble Company (NYSE:PG), Wal-Mart Stores, Inc. (NYSE:WMT), Exxon Mobil Corporation (NYSE:XOM), You can sleep well with those companies in your portfolio. With bond yields at record lows investors are also looking for income. Many stocks have dividend yields greater than the yields on their bonds. You can hear the dividend stock whisper its seductive appeal: “I yield 3%, choose me.” And many advisors and investors do.
Historically, buying high-yielding dividend stocks has been a great strategy. This study (the dividend studies begin on page 30) by Tweedy Browne shows how selecting high dividend stocks has handily outperformed the market in the past. You get even more outperformance (at least historically) from buying only the high dividend stocks that have low payout ratios. High dividend stocks have even been less volatile and fallen less during bear markets.
Ah, the perfect panacea for your portfolio: dividend stocks.
So, where to buy them? Most likely a mutual fund. Either a fund you choose or one an advisor sells to you.
Fidelity and Vanguard are the two largest fund companies. Let’s see what they have in this regard. Keep in mind that the S&P 500 (INDEX.INX) currently has a dividend yield of 1.95%, according to Morningstar.
The Fidelity Equity Income Fund (FEQTX) looks like the closest thing Fidelity has to a fund that focuses on stocks currently paying out high dividends. Here is what Fidelity says about the fund: “Normally investing at least 80% of assets in equity securities. Normally investing primarily in income-producing equity securities that pay current dividends and show potential for capital appreciation, which tends to lead to investments in large cap ‘value’ stocks.” There are a lot of caveats and qualifications in that text.
The fund has a yield of 2.34%. That is barely above the S&P 500. The fund also has a beta of 1.11. That means the fund is 11% more volatile than the S&P 500. I also looked up the historical returns. The fund lost 40% in 2008, which is greater than the loss of the S&P 500 that year. So what’s going on with this “dividend fund”?
Here is the list of the fund’s top 10 holdings from Fidelity’s website.
Right away there are some problems. The fourth largest holding is International Business Machines Corp. (NYSE:IBM), which has a dividend yield of 1.65%. That is below the average yield for the S&P 500. IBM stock has done well lately, and Warren Buffett recently made a huge investment in IBM. I’m sure International Business Machines Corp. (NYSE:IBM) is a great company and a great investment, but is it appropriate for a fund that is telling investors it aims to provide high levels of dividends? I doubt it.
The third largest holding is Wells Fargo & Company (NYSE:WFC). Wells Fargo has a dividend yield of 2.%. Not much better than average. Wells Fargo is in the news lately for the rapid growth of its mortgage loan portfolio. That might sound good until you realize the only way to rapidly grow a loan portfolio is to charge lower rates, and lower rates mean you are in danger of under pricing risk. But, whatever the case, I don’t follow Wells Fargo closely; maybe it is a good investment. Does it fit in with what the fund says it does? Again, I doubt it.
The fund also owns two “super major” oil and gas companies: Chevron Corporation (NYSE:CVX) at 3.1% dividend yield and Exxon Mobil Corporation (NYSE:XOM) at 2.4% dividend yield. Here are the yields of the other four super majors: Total SA (NYSE:TOT) (EPA:FP) 5.1%, ConocoPhillips (NYSE:COP) 4.7%, Royal Dutch Shell plc (NYSE:RDS.A) (NYSE:RDS.B) 4.5%, and BP PLC (NYSE:BP), 4.4%. The fund has its largest holdings in the two companies that pay the lowest dividends.
The fund also owns three healthcare stocks: Johnson & Johnson (NYSE:JNJ) at 3.5% dividend yield, Wells Fargo & Company (NYSE:WFC) at 3.6% dividend yield, and Merck (MRK) at 3.8% dividend yield. Here are the dividend yields of two healthcare stocks in our dividend fund and one we are considering buying: Novartis AG (NYSE:NVS) 4.2%, GlaxoSmithKline plc (NYSE:GSK) 5%, and Roche Holding Ltd. (PINK:RHHBY) 4.1%. (For the record we also own JNJ as well as Pfizer but will likely be selling Pfizer in the coming months.) I have talked to a lot of people in the pharmaceutical industry; in fact, my office is right next to someone who works in the pharmaceutical industry. I have yet to hear anyone say anything good about the company culture and work environment at Wells Fargo & Company (NYSE:WFC). Excluding Lipitor, Pfizer is in pretty good shape as far as patents are concerned, but so are Roche, Novartis AG (NYSE:NVS), and GSK once they get through their mini patent cliffs in 2013. In fact, in addition to paying higher dividends, Roche, Novartis AG (NYSE:NVS), and GSK have much more steady (if unspectacular) growth and pipeline prospects over the next five years as well as well diversified patent portfolios.
The other three stocks that round out the top 10 for Fidelity are General Electric (GE) at 3.2%, Microsoft Corporation (NASDAQ:MSFT) at 2.6%, and perennial dividend favorite AT&T Inc. (NYSE:T) at 4.8%. Intel Corporation (NASDAQ:INTC) and CA Technologies (NASDAQ:CA) are two tech stocks we own that yield 3.6% and 4%. Both have explicitly made returning cash to shareholders via dividends a part of their capital allocation plan. At Microsoft, CEO Steve Ballmer is still walking around with the company checkbook looking for overpriced companies to buy. (In all fairness we own Microsoft in our other fund, so maybe I’m exaggerating a bit when describing Ballmer.)
If you bought this fund expecting performance that approximates the Tweedy, Browne study you’d probably be greatly disappointed as it appears the fund just buys whatever it wants as long as the stock pays any sort of dividend.
Let’s look at Vanguard.
Vanguard is the world’s second largest fund family. They offer a bunch of dividend funds. Their High Dividend Yield Index Fund (VHDYX) has the highest yield that I could see by quickly scanning the dividend fund list. Here’s what Vanguard says about the fund: “This index fund seeks to track a benchmark that provides broad exposure to U.S. companies that are dedicated to consistently paying larger-than-average dividends.”
The fund yields 3.2%. That is substantially better than the Fidelity fund and the S&P 500. So Vanguard has a real dividend fund, not a regular large cap mutual fund dressed up in dividend fund clothes.
Here are the 10 largest holdings.
We already talked about seven of the above (Exxon Mobil Corporation (NYSE:XOM), Microsoft Corporation (NASDAQ:MSFT), AT&T Inc.(NYSE:T), General Electric Company (NYSE:GE), Chevron Corporation (NYSE:CVX), Johnson & Johnson (NYSE:JNJ), and Pfizer Inc. (NYSE:PFE)).
Wal-Mart (WMT) is a great company. Warren Buffett is a big shareholder. Wal-Mart has recently started refocusing on Every Day Low Prices after briefly flirting with trying to be a more upscale retailer. With our economic malaise and real income