The tip of the iceberg for dividend stocks

More companies are able to initiate and raise dividends just when investors want them most

Highlights
>>Post-crisis equity investors
seek to lower portfolio
volatility. Dividend stocks
have provided higher returns
with less risk compared with
non-dividend payers.
>>Baby boomers are retiring now
with much smaller nest eggs
than they had anticipated.
They need reliable sources of
income and growth.
>>Cash-rich companies are
in a position to pay and
potentially grow dividends,
while dividend payout ratios
are historically low.
>>Active managers leverage
in-depth research to uncover
promising opportunities
among companies likely to
initiate or raise dividends.

After a strong performance from dividend stocks in 2011, many investors are
wondering what lies ahead for the group. In our view, a combination of forces has
created a compelling opportunity in dividend stocks today and for the long term.
On the one hand, investor demand for dividends is strong, driven by a post-crisis
desire to reduce portfolio volatility, a need for income among baby boomers
entering retirement and the appeal of potential income growth inherent in the
stocks. At the same time, cash-rich corporations are now in a strong position to
pay dividends and possibly increase them from todays historically low levels.
The key for investors will be identifying companies likely to initiate or raise
dividends two actions historically seen in dividend stocks that outperform.

Post-crisis equity investors seek to lower portfolio volatility

In the wake of the economic downturn, many investors are seeking to reduce
portfolio volatility and preserve wealth. Behavioral finance studies show that
people give greater weight to their most recent experiences. We not only
focus on what has happened recently but also tend to over-generalize to
the future.1 Thus, we often believe recent bad news means the future will
unravel perhaps very quickly. In addition, the theory of loss aversion
suggests that we experience deeper emotion from a loss than we would from
an equally sized gain. Its no wonder then that many investors remain focused
on reducing portfolio risk, even amid signs of an improving economy.
Historically, dividend-paying stocks have been among the more conservative
areas of the equity market, offering investors a lower volatility, higher quality
option. Dividend-paying companies tend to be established, well-managed
enterprises with recognized brands. As a result, in down markets they often
retain value better than non-dividend payers do.
In fact, companies that raise or initiate a dividend have historically generated
strong returns with less risk than companies that do not pay a dividend
(Exhibit 1). Even companies that pay dividends but do not increase them
have outperformed non-payers by a wide margin.

 nxiety, Investing and Time Perspective, Psychology Today. September 29, 2008.
A
http://www.psychologytoday.com/blog/anxiety-files/200809/anxiety-investing-and-time-perspective

Dividend payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities
in the event of a recession or adverse event affecting a specific industry or issuer.

The Tip of the Iceberg for Dividend Stocks

Exhibit 1: A history of lower risk, higher return:

Dividend-payers vs. non-payers
Average annualized return (%)
Lower return
Higher return

S&P 500 Index returns 03/31/8603/31/12

10
8

Dividend growers
and initiators
Dividend payers
with no change
Non-dividendpaying stocks

9.6
7.2

6
4
2

1.7

Performance in this
example is represented
by the S&P 500 Index and
assumes reinvestment
of all income.

0
5
10 15 20 25 30
Lower risk
Higher risk
Average standard deviation (%)

Past performance does not guarantee future results. You cannot

invest directly in an index.
Source: Ned Davis Research, Inc. 03/31/8603/31/12
Graph indicates that stocks have tended to perform better while paying
or increasing dividends. Returns based on monthly equal-weighted
geometric average of total returns of S&P 500 Index component stocks
with components reconstituted monthly. Individual stocks may have
moved from group to group over the time period shown.
The performance is not indicative of any particular product. Standard
deviation is applied to the annual rate of return of an investment to
measure the investments volatility.

Baby boomers are retiring now, and need sources

of income and growth
Retirees are more reliant than ever on investment income.
Next to Social Security, investment income is the largest
source of income for retirees.2 Its also under the most
pressure given todays historically low interest rates. In fact,
since 1984, Treasury yields have been trending downward,
with the safest, shortest-term rates now near zero.
The latest direction from the Federal Reserve indicates
short-term rates are likely to stay close to zero until at
least mid-2013. Some investors dont expect a turn in
rates until 2014. Even when rates do rebound, there is
little likelihood the increases will be sharp given the
Federal Reserves vigilance in controlling inflation.
Meanwhile, the financial crisis has ravaged the portfolios
of many baby boomers, leaving them with little to no time
to make up those losses before they start drawing down
their savings. Instead, they face entering retirement with
a much smaller nest egg than they had counted on.

2
3

Although theyre not the only source of investment

income for retirees, dividend-paying stocks can offer
two important advantages:
>>Capital appreciation potential. Carefully selected
dividend companies could provide reliable income as
well as share price appreciation potential without adding
significantly more risk to a retirees overall portfolio.
>>Income growth potential. Unlike fixed-income
instruments, corporations have the flexibility to increase
dividend payments on stocks. This can boost the total
return for investors who reinvest the dividend and result
in higher payments to investors who rely on the income
from dividend distributions.
Conservative retirees may also find dividend stocks
preferable to more speculative equity categories.

Cash-rich companies are in a position to pay and

potentially grow dividends
Throughout the financial crisis, company managements
focused on cost cutting and strengthening balance sheets
in order to remain competitive. As a result, many are now
operating from lean, highly efficient positions. Theyre also
rich with cash.
Non-financial U.S. companies rated by Moodys Investors
Service held $1.24 trillion in cash as of December 2011,
up 3% from 2010s record of $1.2 trillion.3 The Federal
Reserve reports that cash levels among non-financial
companies are the highest theyve been since the central
bank began tracking the figures in 1952.
With interest rates historically low, high cash levels are
dilutive to the corporate balance sheet. In order to
demonstrate their wise stewardship of capital,
managements must put that cash to work. They have
a few options:
>>Reinvest capital back into the company through research
and development (R&D)
>>Pursue mergers and acquisitions (M&A)
>>Initiate share buybacks
>>Initiate or raise dividend payments to shareholders
Arguably, many companies have ample cash to enact more
than one of these options.

Fast Facts and Figures about Social Security, 2011. Social Security Administration. August 2011.
Moodys: U.S. Non-Financial Companies Hit New Cash Stockpile Record. March 14, 2012. http://online.wsj.com/article/BT-CO-20120314-709508.html

The Tip of the Iceberg for Dividend Stocks

($)

Exhibit 2: Are more dividend increases coming? Cash levels are high...
2,000,000

20%

1,500,000

15%

1,000,000

10%

12/10

12/11

12/09

12/10

12/08

12/09

12/07

12/08

12/06

12/07

12/05

12/06

12/04

12/05

12/03

12/04

12/02

12/03

12/01

12/02

12/00

12/01

12/99

12/00

5%

12/99

500,000

12/11

0%

S&P 500 Index companies' cash

S&P 500 Index companies' cash as a percent of market value
Source: FactSet Market Aggregates, December 1999-March 2012
Past performance does not guarantee future results.

Exhibit 3: Are more dividend increases coming? Dividend payout

ratios are low...
80%
70%
60%
50%
40%

06/11

06/07

06/05

06/03

06/01

06/99

06/97

06/95

06/93

06/91

20%

06/89

30%

Dividend payout ratio

Source: Standard & Poors. Based on trailing four quarters of dividends and earnings.
Full four quarters worth of data for period ending 06/30/11 includes partial estimates
for dividends and earnings.
Past performance does not guarantee future results.

We believe dividend actions will be a preferred choice among boardrooms.

The lessons learned from the financial crisis suggest that managements
are likely to remain focused for some time on maintaining ample cash
levels, continuing to run lean and using cash in shareholder-friendly ways.
In addition, favorable dividend actions tell investors a company is strong,
its debts and other liabilities are covered, and it is operating efficiently.
Thus, initiating or increasing dividends is one way managements can
help build and/or restore investor confidence in their stock.
In our view, the stage is set for a long-term uptrend in dividends. The
S&P 500 Index dividend payout ratio is currently near 30% compared
with a historical average of closer to 55% (Exhibit 3). Given todays high
corporate cash positions, we expect a steady increase over the next
several years.
3

Potential dividend tax increase

will it matter?
With the so-called Bush tax cuts due to
expire on December 31, tax rates on
dividends for wealthier investors have
a real chance of rising from the current
15% rate to a high of 39.6%. Does this
undermine the attractiveness of
dividend-paying stocks? In our view, a tax
increase would not substantively affect
the valuation of dividend-paying equities
for a few reasons:
>>The increase is not a given. Older,
income-focused voters have significant
political might.
>>The tax would only affect individuals
with incomes greater than $200,000
or joint returns of more than
$250,000. Based on IRS data, 35%
of dividends paid to individuals went to
taxpayers making less than $200,000.
Total dividends received by individuals
making more than $200,000 (only
3.2% of tax returns) was about $244
billion (2007 data), but only $101
billion of that was in the form of
qualified dividends, the area affected
by this potential change. Therefore,
only 40% of the dividends received by
those 60% of the people affected, or a
total of around 24%, would be at risk.
>>In our opinion, wealthier investors are
likely to react by rechecking how they
hold dividend-paying accounts and, in
all likelihood, would allocate income
more aggressively into non-taxable
savings vehicles.
After assessing all the puts and takes,
we conclude that the effects of this
potential tax action are unlikely to have
a significant impact on how the market
values dividend-paying equities. In fact,
the more we dig into this issue, the more
it strikes us as a very ineffective way to
increase government tax yields.

The Tip of the Iceberg for Dividend Stocks

Active managers leverage in-depth research

to uncover todays opportunities
In our view, the greatest potential today lies not in the highest yielders,
but rather beneath the surface among high-quality companies with the
potential to grow or initiate a dividend. Exhibit 1 illustrated the overall
risk/return tradeoff of dividend payers vs. non-payers.

Yield in (once) unexpected

places non-traditional
dividend-paying sectors

Exhibit 4: Outperformance often follows a raised dividend

Relative returns of the largest 1,500 companies by market capitalization
1953March 2012
Holding periods
Previous year

One
month

Six One year Two years Three

month
years

Equally weighted return relative to equally weighted universe

Raised dividend

5.3

0.4

1.3

1.9

2.1

2.3

Initiate/reinstate dividend

9.6

0.7

1.1

1.9

5.5

11.1

Flat dividend

-1.6

0.0

0.3

0.4

0.4

0.2

Cut dividend

-6.0

-0.5

-0.2

0.1

0.1

0.3

Eliminate dividend

-14.2

-1.1

-2.7

-3.0

-0.3

3.4

3.8

-0.1

-0.9

-1.4

-1.6

-1.2

No dividend

Source: Empirical Research Partners Analysis, March 2012

Past performance does not guarantee future results.

Exhibit 4 broadens the analysis by 30-plus years and breaks out the
returns by holding period. The results are telling:
>>Companies that have raised their dividend outperform an equally
weighted universe of companies by approximately two percentage
points in the year following the increase.
>>They continue to outperform for up to three years later.
>>The market seems to discount the corporate decision to increase the
dividend for a year prior to the dividend action.
These statistics tell us that successful dividend stock selection requires
the ability to anticipate which companies are likely candidates to raise or
initiate a dividend.
Active portfolio managers leverage intensive research to identify
opportunities among dividend stocks. Professional portfolio managers
and research analysts dig deep into a companys ability to generate and
sustain cash flow. When a corporations cash returns exceed what it
needs to grow the business, it has the firepower to initiate favorable
dividend actions. That said, not all dividend-paying stocks are the same.
Companies can cut dividends as well as raise them, which is one reason
careful analysis of each stock is important.

From Columbia Management

2012 Perspectives The Evolution
of Dividend Investing and the Rise
of Non-Traditional Dividend Sectors
by Paul Stocking and Laton Spahr.

We believe that the recent behavior

and outperformance of the highest
dividend stocks has laid the
groundwork for a shift toward new
dividend themes moving forward.
The high relative valuation in
sectors like utilities and staples
has opened up an opportunity to
look at nontraditional dividend
sectors like technology, basic
materials and consumer
discretionary to find hidden
dividend gems with increasingly
sought-after characteristics, such
as high yield and predictable
dividend growth.
As a result, we expect faster
adoption of more shareholderfriendly dividend policies across the
market, allowing new leadership to
emerge in the sweet spot of high
dividend/high growth.
Read the complete article here.

The Tip of the Iceberg for Dividend Stocks

Today, dividend stock portfolio managers are finding value in two places:

INCOME-ORIENTED EQUITIES

>>The dividend aristocrats. Attractive dividend payers typically have a

long-term record of returning value to shareholders through dividends,
including a history of consistently paying and increasing dividends.
Known as the dividend aristocrats, these companies have solid balance
sheets and long-term track records of being wise stewards of cash.

Implementing a
dividend strategy
in your portfolio

>>Non-traditional dividend-paying sectors. Many mature companies

that are no longer in the expansion phase have solid cash positions,
making them candidates to become dividend payers. They have the
ability to initiate a dividend and the long-term ability to increase
dividends (see sidebar on page 4).
The stage appears set for ongoing opportunity among dividend-paying
stocks. Investors are seeking the very benefits that dividend stocks
provide, including low volatility and income that can potentially increase
in the future. At the same time, strong corporate cash positions and low
dividend payout rates suggest there are many companies today that are
capable of initiating and raising dividends. And history tells us this is more
important than the yield itself in determining which stocks will outperform.
We believe portfolio managers who can identify the dividend leaders will
find this is only the tip of the iceberg for dividend stocks.

A history of stability and consistency

make dividends a favored investment
strategy among investors, and the
current market environment has
created a strong opportunity for
income-oriented investing. Consider
supplementing the fixed-income
positions in your portfolio with
dividend-paying solutions from
Columbia Management.
Columbia Dividend Income Fund
A: LBSAX, C: LBSCX, R: CDIRX, Z: GSFTX

Our investment process focuses on

companies that generate significant
and sustainable free cash flow
and have the potential to reward
shareholders through increased
dividend payments over time.

Richard Dahlberg, Senior

Portfolio Manager

Columbia Dividend Opportunity Fund

A: INUTX, C: ACUIX, R: RSOOX, Z: CDOZX

Columbia Global Dividend Opportunity

Fund (formerly known as Columbia
Strategic Investor Fund)
A: CSVAX, C: CSRCX, R: CSGRX, Z: CSVFX

Using an integrated valuation analysis,

fundamental research and behavioral
views, we seek to generate a high level
of current income by investing in
companies that have historically paid
consistent and increasing dividends.

Paul Stocking, Portfolio Manager

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