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What a Recovery in 2011 Means for Dividend Stocks

Jeremy Glaser

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. I'm here today with Josh Peters. He is Editor of Morningstar Dividend Investor. We're going to take a look at what a recovery in 2011 could mean for dividend stocks.

Josh, thanks for joining me.

Josh Peters: Good to be here Jeremy. Happy New Year to you.

Glaser: Thank you very much. Let's take a quick look back at 2010, maybe the recovery kind of had fits and starts throughout the year, how did dividend stocks perform over the last 12 months?

Peters: I think best place to start to just have a reference point the S&P 500 did 15.1% on a total return basis including reinvestment of the dividends paid by those companies. Some of the dividend indexes that I look at like the Dow Jones Select Dividend Index, Morningstar's own Dividend Leaders Index which are geared more towards just higher yielding stocks, did a little bit better couple of percentage points better than that.

The two modeled portfolios that I manage is actually kind of an interesting divergence. The Harvest Portfolio which is really designed to try to maximize yield while still getting good growth and good overall total return did 28% which really surprised me on the upside, very pleased with that result.

People were looking for yield as interest rates continued to stay low but we also saw a resumption of dividend growth for some of our holdings especially from the master limited partnerships that we owned. The Builder side which has lower yielding stocks actually more cyclical exposure and over the long run where we think more dividend growth. It actually lagged the market a little bit did 14.4%.

So, overall I think it was a decent year for our recommendations somewhere fell a little bit short. Abbott Labs and Johnson & Johnson two healthcare stocks I like very much, I think still very good dividend growth prospects. They really weighed on our performance at the bottom end but dividend yield really had a lot to deliver not just in terms of income but also capital appreciation last year.

Glaser: What's your expectation for the economy in 2011 then?

Peters: Well, I'm not really sure and actually that's the question I try not to ask at least as any specific year or quarter or monthly employment report or something like that is concerned. It's very hard I think to make a forecast that once we'll be accurate and then to derive investment conclusions directly from that because there is always a center play between the uncertainties around the forecast what are our expectations what's built into prices.

By the time that forecast becomes a report, even if you're right, the market is going to be looking that much further ahead. So, I really try to stay out of that guessing game. Instead what I try to do is just think what are the downside risks and then manage them. If the recovery falters again and we really have a slog of say very low GDP growth in 2011, I think the kind of companies that I have bought with high yields and the ability to continue growing their dividends under stress, under some economic stress, that those will be very rewarding companies to own.

If the economy really takes off and proves that this wasn't already discounted in the rally that we've had here since the summer, then probably going to fall behind on a relative basis. I think our portfolios still do well in that situation, but maybe not as much as the S&P 500 or the more speculative sectors of the market.

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Glaser: I know it can be harder to play armchair investor psychologist. But do you think that we're going to see again next year that there's going to be just this insatiable appetite for yields with some security or do you think that risk taking is really going to come back into vogue.

Peters: Well, you've certainly seen risk taking become much more popular in the last couple of months. December was a terrific month for the stock market. Dividend payers ended a lag behind, not at all unusual. The fact is that the company or stock that went from 10 to two during the crash and survived with its earning power intact has lot more upside than something that went from 10 to eight. That's just the name of the game.

Now, the real question I think is not so much do you want to make some sort of a sentiment shift or tactical shift from conservative stocks into more aggressive names, as you know just what kind of an investor do you want to be. Because you're not going to get the forecast over the short run right all the time. You have to be very nimble if you want to take that more speculative approach. You have to be prepared perhaps to take some big losses along with being wrong a good percentage of the time.

What I would rather do is kind of look out three to five, better yet, five to ten years down, say, what kind of companies can actually meet a target for total return over these longer term horizons through dividends and dividend growth and the capital appreciation that should encourage and focus on that, and then also again continue to pay attention to the downside risks. I'm not interested in owning a stock whose dividend might be cut if there is an unexpected recession, because when there is a recession, it's going to be unexpected.

So, to me, I'm not thinking in terms of why don't you become more aggressive because perhaps the economy is picking up a little bit faster. I just want to keep my expectations both reasonable and long-term oriented. And I use that to help to govern how I construct the portfolios.

Glaser: For investors, you do have that 5- to 10-year time horizon. Do you have any stocks that look attractive right now?

Peters: The funny thing about it is there aren't a whole lot of stocks I think in the market generally or within the high yield universe that are really all that attractive. And what I tried to do is really just pay a discounted price, get the classic Graham and Dodd margin at safety. The less you pay, the less you have to lose and the more you have to make over the long run. Lower price is going to mean a higher dividend yield that's going to put more money in your pocket per dollar invested right away. And there's just not a whole lot of stocks out there that I'm really enthusiastic about where they are trading at right now.

This is kind of pricing the market as opposed to timing the market or the economy or other events. But one thing that I do like quite a bit and actually you just made official a dividend increase here this week is Spectra Energy, symbol is SE. One of the largest companies involved in the natural gas transportation business in North America. A huge network of pipelines and gas processing plants; really spreads just about everywhere that there is to obtain gas in this country.

It's really not that different than a big utility except that the economics around its business are actually, if anything, a little bit more favorable. You've got, I think, better long-term growth prospects as America continues to consume more energy, more natural gas in particular, the sources of supply shift around that creates opportunities to build new pipelines. Right now the stock yields a little bit over 4%. It announced a dividend increase or actually it said it planned to raise its dividend in December; made that official raising that annualized rate from $1 a share to $1.04.

I actually bought this stock back in September adding it to the builder portfolio for the first time and I didn't really expect them to raise their dividend until maybe 2012 at the earliest. So, seeing that dividend increase come along sooner than I expected really made me feel like the business was coming along, generating the underlying growth in the business that would really support what I think is a low double digit type of total return over the long run, and without a whole lot of risk at that, because it's not much riskier than a utility stock either.

Glaser: Josh, as always, thank you for your thoughts.

Peters: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser.