Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Josh Peters. He's editor of Morningstar DividendInvestor. We're going to talk about what's happening in the world of dividend stocks.
Josh, thanks for talking with me today.
Josh Peters: Good to be here, Jeremy.
Glaser: So, let's start with Abbott Laboratories. This is a company that I know you've liked for a long time, but it's getting ready for a spilt-up of the business.
Glaser: What's your take on that split, and does it impact the way that you're buying or not buying Abbott shares?
Peters: Yeah, it's actually one that has turned out to be kind of disappointing in the end. I mean we've made a good return in the Abbott shares that we've held in the DividendInvestor model portfolios, but the split-up of the company into two pieces really makes those parts, I think, less valuable for dividend investors in a whole. I think I can describe it pretty quickly. Abbott Laboratories is spinning off its branded pharmaceutical business; that's the new business that's going to be called AbbVie. AbbVie is going to be the big dividend payer. It's targeting a pretty generous payout ratio. My guess is this stock will probably yield 4% or maybe even 5%.
The problem with AbbVie is that half of its revenue and probably more than half of its operating profits are going to come from a single drug called Humira. Humira is a great drug. It's been growing very quickly. It doesn't face the kind of patent cliff that a drug like Lipitor did because it's a biologic, and those are much harder to create generic competitors for. But it's really a risk management question, the way I view it. If anything bad happens to that one drug, if somebody in Iceland finds out it causes warts, that threat has to go right down to the dividend. So, for me, I'm glad AbbVie is paying out that cash, but I think it's a dividend that you have to be a little bit worried about if the unforeseen happens. And that is always I think what you want to be creative about is, "What could be unforeseen come out and blow my dividend out of the water?"
Then there is the rest of Abbott Laboratories, which is a great mix of businesses today. It's going to be a great mix of businesses even without the branded pharma business; it's got diagnostics, nutrition, medical devices, and what they call branded generics in there. The problem there is that's going to be the growth business that doesn't want to pay the generous dividend anymore. My guess is that stock might only yield 2%, plus or minus. Typically, as a dividend seeker, I want to get at least 3%. When I get 3% yield, I'm getting a lot more than I could get on Treasuries. I'm getting competitive with what I could get on corporate bonds, higher-grade corporate bonds. But I'm getting the growth; I'm getting the potential for capital appreciation. If the stock only yields 1% or 2%, I'm not getting the income component I really need in order to make my strategy work. So, even though we still think that Abbott is a little bit undervalued heading into the completion of the split-off, I just don't see that much appeal from here for the two pieces. Frankly, I wish it was staying altogether.
Glaser: So, utilities is another area that certainly is of a keen interest to many income-seekers. What's happening there? Is there anything interesting to note?
Peters: Well, we've seen a sell-off here [recently]. I think some of that might relate to the threat of higher dividend taxes, now that the election is over and we know that President Obama is going to remain in office. He's been campaigning in part on wanting to raise implicitly dividend taxes and to a lesser extent capital gains taxes for higher earners. But to me that's just a little bit too cute. If you're a hedge fund, you want to bet on the election, and you're short utilities stocks because you think Democrats are going to win, that's not really getting down to the heart of the matter.
To me, it's still about what kind of dividends can these companies provide on a pretax basis. If I want to keep tax burden low, I'm not probably going to be hit in all likelihood with a big tax increase if I am a more middle-class or even upper-middle-class investor not collecting millions of dollars year in dividend income. Or I can own them in my IRA, my 401(k). [Higher taxes] affects all dividend-paying stocks, but I think [it affects] utilities in general because so much of the value of the utility is wrapped up in that dividend. People are focusing on the tax thing, and I think if you get too bent out of shape about this one issue, you're going to miss the rest of the merit.
What we've seen is that utilities are coming back down closer to fairly valued. If I see a stock like, say, Southern Company, which I haven't owned but I'd like to own, trade into a 4-star territory, 5% or more below our fair value estimate, I'm going to be very interested. I don't think you should necessarily have to wait for a huge discount before buying a company of that high quality.
Glaser: So, it sounds like a sector to keep our eyes on.
Peters: Yeah. If it continues to trade down then that could be I think a really good opportunity for investors, who have been shutout of some of the really good regulated utilities, to be able to give those stocks another good look.
Glaser: How about more cyclical stocks? Are they looking any more attractive?
Peters: This has been one of the more interesting developments this year. Even though the stock market, at least up until [recently], has been performing well--it's looked like a classic bear or bull market--it's been a lot of the defensive names that have been leading the rally, a lot of the highest-quality names. And some cyclical businesses that are still high-quality, like an Intel or an Emerson Electric, are now offering in some cases yields that are competitive with utilities. Now I'm glad to utility stocks are getting a little bit cheaper; I don't mind paying a fair price for a utility. But if I have the opportunity to buy Intel at a yield over 4%--and knowing that that company has really constructed its dividend policy to make sure that it can grow the dividend in the good years and still maintain it even in this cyclical industry's bad years--I'm comfortable with that. It's hard to buy a cyclical at the exact bottom. I think you find a good price that you'd be happy with, say, three to five years out, and then be prepared to add a little bit more to your position if the stock falls after you buy it
Glaser: Josh, thanks for thoughts today.
Peters: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.