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By Dan Culloton | 06-13-2013 10:00 AM

Cohen: Dividends Have Decidedly Not Had Their Day

Long-term investors shouldn't sell out of solid dividend-payers just because of temporary price dislocations, says the ClearBridge Equity Income Fund manager.

Dan Culloton: Dividend paying stocks have outperformed the broad market over the past five years. Recently, though, dividend paying stocks have taken a hit.

Here with me to talk about this phenomenon is Hersh Cohen, manager of the ClearBridge Equity Income Fund.

Hersh, thank you for being here today.

Hersh Cohen: Thank you. Pleasure.

Culloton: Well, as we've mentioned, dividend-paying stocks have had a pretty good run recently until May, which has….

Cohen: Gee, I had hardly noticed, ugh...

Culloton: Many people have asked whether dividends have had their day and whether the valuations still look attractive.

Cohen: Oh, my goodness, have dividends had their day? Not only have dividends not had their day, but ... I want to say, over the next 10, 20, 30 years, which is how I know Morningstar thinks people ought to be thinking about it, you tell me a better way to accumulate capital and prepare for retirement.

I like to use this analogy. In the 1950s when Johnny Cash came out, he did "I Walked the Line." I loved Johnny Cash. He was great. And then he kind of fell out of favor a little bit, and what I say is Johnny Cash was great 60 years ago, he's great today, and he's going to be great 60 years from now, although he might wane and wax in popularity.

So, dividends were great 60 years ago. They waned in popularity in the 1990s. They are great again now. They might wane in popularity again if the markets get a big risk-on kind of trade, in the lingo of the day. But why isn't it good that these companies are increasing their dividends at between 7% and 10% a year on average, and many of them, huge dividend increases, despite the fact that the stocks have sort of stopped going up and pulled back, in some cases, 10% over the past month and a quarter. They had big runs. You’ve had … this is the golden age of dividends. The dividend increases are massive. Companies have enormous amounts of cash on their balance sheet. The aftertax payout ratios are still only about a third of aftertax profits, whereas historically it could be as high as 50%. And there's pressure from investors to return capital.

So I think if people would worry less about the asset value than about the income generated from their portfolio, I think they're going to be better off. And I don't know where else people can get those kind of raises. They're not getting them in their jobs. I don't know where people can get the kind of raises that they're getting from these companies raising dividends.

Yesterday, I'm here at the Morningstar Conference, and I get emails: Caterpillar Tractor raises its dividend 15%, Target 19%. This is the most spectacular four and five months of dividend increases that I have ever seen. Texas Instruments, 33%; Qualcomm, 40%; Walmart, 18%; 3M, 8% and they've done it for 50 consecutive years. Proctor & Gamble. On and on and on, and it's just a great story. Why would that story not be good?

Listen, I don't like it if my asset values are down, but I'm trying to train people, and I have the long-term experience to know, that you can't be concerned about every squiggle in the marketplace.

The value of your assets, yes, it matters, because the wealth effect means something to people's behavior, but the amount of spendable income--that's going to continue to go up from dividends.

So, therefore, I think the story is as good as it ever was. Are the stocks as cheap as they were when I was here in 2010? No. Are they overpriced? No.

Culloton: That was my follow-up question. It has been noted, both within Morningstar and outside of Morningstar, that there are certain sectors, traditionally dividend-paying sectors, where the valuations and P/Es look a little bit elevated, typically telecom, consumer defensive, or consumer staples.

Cohen: Yeah, utilities.

Culloton: So would you agree with that that…

Cohen: Well, I agree that they are a little bit extended, and I knew at the end of April these stocks were extended. But I have to tell you, I can't turn my portfolio or I won't turn it over 100% or 70%. So you live with these corrections. Kimberly-Clark, great company. It still has a 3.2% dividend. The stock got to $106 on better-than-expected earnings, and then it came down 10%. So now it will work its way back. Am I supposed to sell it, all of it, just because it had a great quarter and got a little bit ahead of itself?

Electric utilities--the ones we own have good records of dividend increases. Wisconsin Energy is committed to kind of raising their dividend 8% to 10% a year. NextEra, which is the old Florida Power & Light, does a great job raising its dividend. Northeast Utilities. So these are going to be fine. Are they expensive on a P/E basis? Yes, relative to where they have been in the past. However, on a yield-to-Treasury-yield basis, I think they're still OK. Are they as cheap as they were two years ago? They are not, because I think people, in seeking yields, have taken them up. Does that mean you sell them because their yields are 3.9% or 3.8% and the stocks are a little extended? I wouldn't.

One of my greatest personal investments, of all the stupid things, was in the late '70s, when I would cobble together a little money and buy 100 shares of a stock, and I would put them away so that I wouldn't be tempted to sell them. Then I got into the dividend reinvestment. One of the greatest … and I still own it … Public Service Electric & Gas. It was yielding a lot at the time. Don't ask me why I brought a utility then, because I would also buy 3M and Exxon and Johnson & Johnson and IBM when I had a chance. Just long-term. I own all of those still, and have reinvested. And in each case, the dividends are more each year than I paid for the stock in the first place. That doesn't happen by just clipping them off, trimming them. That's why I wanted to put them away.

GE--even with its dividend cut, and now it's restoring the dividend--the dividends are much more than I paid for the stock. That can only happen with, A) with really good companies chosen wisely, and B) giving them lots of room, lots of room, and not getting upset. Was I tempted to sell GE for myself when it was 50 times earnings? Yes. But … I'm not going to worry about it, and so it's OK.

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