By the Global Value and Income Team
Given the widespread search for income, “bond-like” equities will continue to draw capital, but the overall return potential is not compelling.
We believe that there are higher-yielding sources that have been neglected because of a temporary infatuation with “stability.”
Global dividend stocks provide not only an attractive source of income via yield but also the opportunity for valuation expansion, driven in part by growth.
One of the enduring characteristics of the post-financial crisis world is the consistently low level of yields that is punishing savers and igniting a widespread search for income. Central bankers around the world have rewritten the rules of engagement in this post-crisis environment, promising to maintain persistently low benchmark interest rates.
Where do we see opportunities in this environment? In short, go to where the capital will need to go. In our view, capital will increasingly flow toward assets that have an ability to protect real spending power by participating in the global initiative to ignite better nominal growth. As we transition from perceived deflation risk toward asset-oriented inflation, global dividend-paying equities should benefit.
Global dividend-paying equities provide three sources of investment return:
Coupon income — or dividend yield. The search for income has occupied an unusually large portion of the market’s mind, and it is causing meaningful distortions in the pricing of coupon-paying assets around the world. Among equities, even relatively stable markets like the United States are experiencing high valuations in traditional high-coupon sectors, such as telecom and electric utility stocks, real estate investment trusts (REITs) and master limited partnerships (MLPs). These “bond substitutes” have seen the valuation paradigm move from growth toward income.
As long as policymakers continue to manipulate interest rates to abnormally low levels, the relatively high coupons investors can earn in these areas will continue to draw capital. As a result, the overall return potential from many of these investments is not very compelling, given the lack of valuation upside available to drive returns. Simply said, in many coupon-driven equities, the best you can hope for is just the coupon.
When we step outside the most stable and “bond like” equities and look broadly around the globe, we find something more appealing. Exhibit 1 illustrates the current benchmark equity yield available in each major region around the world. Surprisingly, in every region except the United States, dividend yields are higher than the 25-year average. In other words, no other region in the world is as focused on coupon as the U.S. International markets provide not only yield but also a second, more significant source of return — valuation expansion.
Valuation expansion. For us, the fact that many markets are trading at or above their average dividend yields provides a strong valuation signal for global dividends. There are a number of ratios that could expand to drive valuations and deliver strong investment returns, including price/earnings and price/ book value. The highest yielding dividend stocks in emerging markets have lower price-to-forward-earnings ratios than those in developed markets, including the U.S.*
Exhibit 2 illustrates how the highest-yielding markets worldwide have turned out the best long-term performance. In fact, in every 25-year period since 1900, the highest dividend yielding countries have provided the highest total returns. Admittedly, this tells us almost nothing about any single year or other short-term investment horizon. However, we believe the combination of uniquely high global equity yields versus history and the intuitively contrarian track record of outperformance among countries that have high yields creates a compelling case to allocate to global dividends.
Higher growth rates. To find the third source of return, we ask the question, “What unlocks the opportunity for good long-term returns?” The broad-brush answer is improved corporate earnings growth and greater risk tolerance among investors.
Simple observations through history show us that risk acts like a pendulum between fear and greed, and we are currently stuck at the fear end of the spectrum. To unstick this pendulum, we would likely need to see a combination of surprisingly good growth and/or surprisingly good investment returns from “risky” assets. (This could also show up as surprisingly bad returns in “risk free” assets.) It remains to be seen what will transpire for risk tolerance, but the fundamentals for growth among global dividend payers look promising.
We’re bullish on global dividend-paying stocks. The current, distorted, low-yield environment has taught investors a dangerous lesson about looking for coupons and valuing assets accordingly. We don’t blame investors for searching for coupons, we simply believe that there are compelling sources that have been neglected because of a temporary infatuation with “stability.” We believe that extending that income search a bit further down the spectrum of volatility will more than compensate investors for the risk they take. Global dividend stocks provide not only a compelling source of income via yield but also the opportunity for valuation expansion, driven in part by growth. In our view, there is no better combination of return drivers than the one available from global dividend equities.
*Source: Corporate Reports, Empirical Research Partners Analysis, 2012.
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.