Dividends’ Unintended Consequences
Thursday, December 6, 2012
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 42.2%, up 1.3 points
  Neutral: 23.2%, down 1.5 points
  Bearish: 34.6%, up 0.2 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »

There are three unintended consequences on dividend stocks and dividend investors being caused by the uncertainty of 2013 tax rates. The consequences are an extraordinarily large number of special dividend declarations, the early payment of typical first-quarter dividends and the future adverse impact on dividend growth rates for certain companies. These unintended consequences are a subject we are discussing in the December AAII Dividend Investing monthly report, and I’ll share an overview about them here.

Howard Silverblatt, the senior index analyst at S&P Dow Jones Indices, counted special dividend (extraordinary distributions that will not be repeated in the future) declarations from 228 companies occurring last month. To put this number in perspective, total annual (not monthly, but annual) special dividend declarations have averaged 181 over the past eight years. Only 2007 saw more declarations than November 2012 (233 for all of 2007 versus 228 for November 2012).

Whether paying a special dividend is a good thing is debatable. If a company truly has excess cash on its balance sheet that is not needed to fund future profitable projects, then distributing it to shareholders is the right thing to do. AAII Dividend Investing holding Waddell & Reed Financial (WDR) is a company that is using its cash balance to fund a special dividend.

Conversely, Costco (COST), a stock we do not hold, issued $3.5 billion in new debt to pay a special dividend of $7.00 per share. Selling bonds to pay for a dividend is akin to cashing one of those credit card checks sent in the mail so you can have an expensive night out on the town. Well after the joy of the night is gone, the repayment obligation lingers.

Some companies are paying their typical first-quarter dividends before December 31, 2012, to take advantage of known tax rates. For individual investors holding these stocks (or those of companies issuing special dividends), reported gross income for 2012 will rise. Consult a tax professional if you have questions about the implications on your tax liability.

The acceleration of payment dates also impacts future dividend growth rates. By shifting a 2013 dividend payment into 2012, a company risks having databases lower its annualized dividend growth rate for years to come. Here’s why. Assume a company paid a quarterly dividend payment of $0.20 per share in 2012. In November, the company raised its 2013 quarterly dividend payment to $0.22 per share (a 10% increase), but shifted its typical January payment to the end of December 2012. The calculations will show $1.02 in dividends paid in 2012 (four payments of $0.20 per share and one payment of $0.22 per share) and $0.66 in dividends paid in 2013 (three payments of $0.22 per share), a 35% decline in the annual dividend growth rate.

The figures displayed on many websites and used in stock screens will be calculated using the larger cumulative dividend payments in 2012 and the smaller cumulative dividend payments in 2013. This is because the databases aren’t programmed to consider temporary, tax-related actions. Expect to see the annualized dividend growth rates for those companies that are paying their typical first-quarter 2013 dividend before the end of 2012 reduced, or even negative, for years to come. Also expect these companies to be excluded from stock screens that require either consecutive annual dividend increases or a minimum dividend growth rate. (The database used for our stock screens and our Stock Investor Pro screening software does not factor special dividends into the dividend growth rate calculations. I cannot say with certainty how other databases treat special dividends.)

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The Week Ahead

Only two members of the S&P 500 are currently confirmed to report earnings next week: Joy Global (JOY) on Wednesday and Adobe Systems (ADBE) on Thursday.

The Federal Open Market Committee Meeting will hold its last meeting of the year starting on Tuesday. The meeting statement will be issued at 12:30 p.m. ET on Wednesday, followed by the committee member forecasts at 2:00 p.m. ET and a press conference with Federal Reserve Chairman Ben Bernanke at 2:15 p.m. ET.

The week’s first economic reports will be October international trade and October wholesale trade, both of which will be published on Tuesday. Wednesday will feature November import and export prices. The November Producer Price Index (PPI), November retail sales, and October business inventories will be published on Thursday. Friday will feature the November Consumer Price Index (CPI) and November industrial production and factory utilization.

The Treasury Department will auction $32 billion of three-year notes on Tuesday, $21 billion of 10-year notes on Wednesday and $13 billion of 30-year bonds on Thursday.

Hanukkah starts this Saturday (happy Hanukkah!). For those of you who have yet to buy Christmas presents, just 19 shopping days are left.

AAII Sentiment Survey

Bullish sentiment rose to its highest level since March 29, 2012, even as bearish sentiment stayed above its historical average for the 15th consecutive week in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 1.3 percentage points to 42.2%. This is both the highest level of optimism registered by the survey and the first time bullish sentiment has been above its historical average of 39% on consecutive weeks since last March.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 1.5 percentage points to 23.2%. This is the 10th time in 12 weeks that neutral sentiment is below its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, edged up 0.2 percentage points to 34.6%. This is the 15th consecutive week and the 31st out of the last 35 weeks that bearish sentiment is above its historical average of 30.5%.

The short-term outlook among AAII members has improved dramatically since November 15, 2012, with bullish sentiment jumping 13.4 percentage points. A good start to the holiday shopping season and the market’s ability to hold steady despite continued uncertainty about the outcome of budget and tax negotiations in Washington are helping to boost optimism.

Seasonality may also be playing a role. In a report last week, Sam Stovall, the chief equity strategist for S&P Capital IQ, said December has the highest monthly average bullish sentiment readings. According to Stovall, since our survey started in 1987, bullish sentiment has averaged 41.8% in December. December also ranks number one in terms of S&P 500 performance. Stovall calculates an average December monthly gain of 1.36% for the S&P 500, using data dating back to 1900.

Even with the improvement in bullish sentiment, it is worth noting that bearish sentiment continues to stay at above-average levels. Failure by Congress and the president to avoid the fiscal cliff would likely have a damaging impact on individual investors’ moods, especially if it seemed that the standoff would be protracted. Furthermore, many AAII members remain concerned about the pace of economic growth, ongoing political gridlock and Europe's sovereign debt crisis.

This week’s special question asked AAII members for their opinions about companies declaring special dividends or paying their typical first-quarter dividend before the end of this year. The majority of survey respondents said such actions were a good idea given the possibility of higher tax rates next year. Several respondents differed, however, saying that the actions benefited executives and large shareholders, were a ploy to attract new shareholders or may not be the best use of company resources. A small group of respondents were indifferent, saying these actions will have no lasting impact. Several AAII members pointed to the ongoing gridlock over the fiscal cliff as the reason for the special dividends and the accelerated dividend payments.

Here is a sampling of the responses:

  • “Given the uncertainty about tax reform, this may be a good approach for both the companies and investors.”
  • “Great. Less potential tax to pay to the IRS.”
  • “I think it is fine so long as the companies are not borrowing to make the dividend payments.”
  • “I’m not against it. I really wish, though, we had a political system that absolutely worked for all of us citizens.”
  • “It is more in the interest of the CEOs and board of directors than in the interest of the average shareholder.”
  • “I think it is short-sighted and a bad idea.”

» Take the sentiment survey

AAII Asset Allocation Survey

November Asset Allocation Survey results:
Stocks/Stock Funds:
    58.6%, down 1.3 points
Bonds/Bond Funds:
    21.2%, down 0.1 points
    20.2%, up 1.3 points

Asset Allocation details:
    28.8%, down 2.5 points
Stock Funds:
    29.8%, up 1.2 points
    4.3%, down 0.3 points
Bond Funds:
    17.0%, up 0.2 points

Take the survey »

Equity allocations fell to their lowest level of the year as individual investors boosted their cash allocations, according to the latest AAII Asset Allocation Survey.

Stock and stock fund allocations fell 2.5 percentage points to 58.6%. This is the lowest allocation to equity investment since December 2011. It is also the third consecutive month AAII members have reduced their exposure to stocks and stock funds. The historical average is 60%.

Bond and bond fund allocations declined 0.1 percentage points to 21.2%. This is a four-month low for fixed-income allocations. Even with the decrease, November was the 41st consecutive month that fixed-income allocations were above their historical average of 16%.

Cash allocations rose 1.3 percentage points to 20.2%. This is the largest percentage allocated to cash since July 2012. Even with the increase, cash allocations were below their historical average of 24% for the 12th consecutive month.

Optimism about the short-term direction of stock prices remained below its historical average for much of November. Though many of our members take a longer-term outlook when it comes to allocating their portfolios, it is possible that the combination of short-term worries about the direction of stock prices and the uncertainty of the 2013 tax outlook prompted some AAII members to increase their cash levels. Low bond yields and interest rates continue to be problematic for investors who depend on portfolio income.

November’s special question asked retired AAII members how they are funding their retirement withdrawals. Many respondents said they use a combination of dividend income, bond interest and capital gains. Slightly more than a third of all respondents said they use dividend income to fund their withdrawals. Roughly one-quarter said they rely on capital gains and a nearly equal number said they use bond interest.

» Take the Asset Allocation Survey

Wishing you prosperity,

Charles Rotblut, CFA
AAII Journal Editor