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Dividend Warships for Choppy Waters

Josh Peters, CFA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Over the last few weeks, worries about emerging markets have sent stock markets and many currencies reeling.

I'm here with Josh Peters, editor of Morningstar DividendInvestor and the director of equity-income strategy at Morningstar, to see what impact this could have on dividend investors.

Josh, thanks for joining me today.

Josh Peters: Good to be here, Jeremy.

Glaser: Could you walk us through why all of a sudden the market seems so concerned with emerging markets? Why there has been so many movements in so many currencies from Argentina to Turkey to South Africa? What's happening here? Why is the market looking at these countries so differently?

Peters: One reason is that, in most developed countries, North America and Western Europe in particular, you've gotten used to this idea that the economies aren't going to grow much anymore. So, it's been up to both large, multinational companies as well as investors themselves to start looking at some of these other areas of the world, where perhaps there is more growth.

It's not hard to understand, when you have a couple of billion people in emerging markets, a couple of hundred million [of those people] move into the middle class, and that's a dramatic increase in consumption that goes with a rise in standard of living. So that is, I think, still a good opportunity over the very long run--five, 10, 20 years--for companies to find and generate additional growth.

How this plays back to short-run outlooks for corporate earnings and for investor returns, that is a lot tougher. I've always preferred to get my exposure to emerging markets through very well-financed, well-established U.S. and European companies that have stable bases with which to support their dividends, but also have growth opportunities that are obtained through going into these markets. You don't necessarily have to buy a consumer-products company in Turkey in order to get some exposure to those emerging markets. You can do it through a Procter & Gamble or a Unilever.

Glaser: But if you were to own some of these companies, they're still going to be impacted by, at the very least, the currency impact that's happening right now. Is this something that should be on our radar, or is it something you just can't control and shouldn't worry about?

Peters: Well, it should be on your radar. You need to have an idea of what to expect. Most of the companies that we hold in [Morningstar DividendInvestor's] Builder portfolio--which is the traditional blue chip growth and income strategy, 2.5%, 3%, 3.5% types of yields--as well as consistent dividend growth. For a lot of these names, getting the big dividend increases this year might be kind of tough--not just because of the slowdown in these markets, these economies themselves, but just the currency headwinds involved as these companies translate those profits in those countries back into dollars with which to pay dividends.

So, it might not be the best year for some of these companies. But again, I think you step back and say, is the company financially sound? Can they basically continue to maintain their dividend even as some of these areas where they operate go south.

If that holds up and the dividend should be reliable even under an adverse scenario, then you ask yourself, am I getting potentially a bargain here, as people have been scared out of names like Philip Morris International, and Unilever, and Procter & Gamble--a couple of the companies I own in the Builder Portfolio. Philip Morris, in particular, is very attractively priced right now.

They are going to be fine over the next decade, but in exchange for that, you've got to bear a little bit more volatility in the next couple of months, maybe the next couple of quarters.

Glaser: What would happen if some of these issues escalated, and we have something that looks more like the 1997 and 1998 crisis? Would that change your opinion of these stocks, or is it really still good to have that long-term perspective?

Peters: I think it's better to keep the long-term perspective. We went through some very painful circumstances back in '97 and '98. That in turn helped spur a lot of structural reform in these countries that was beneficial. They started to accumulate large foreign-currency reserves, so they could defend themselves against speculative attacks or bank runs, and insulate themselves from some of that volatility. But now they've kind of played out those structural reforms that they've had, and they're looking at needing another round, and that's not necessarily what they're ready to do in some of these countries.

So the waters are getting a little bit choppier, but I don't think it's time to decamp. I think you pay attention to it. But you've got to look back at the company.

Philip Morris typically is going to pay out 65% of its earnings as dividends. That means that they can take a 35% hit, and the dividend is still covered by their annual profits. For a business that, at the end of the day, is still very, very steady, even with some of the currency variations that are involved, that is a pretty large margin to safety against any kind of direct cut to the dividend.

As long as the dividend is safe and likely to continue to grow, then I think you'll look at these types of opportunities as chances to buy stocks that might not otherwise be attractively priced.

Glaser: So, look for the ocean liners and not the dingeys in these choppy waters.

Peters: Like I said earlier, you could buy stocks of companies operating and domiciled in these individual emerging markets. As a U.S. investor, you get told so much about the diversification benefit of international investing. But I feel like I'm at a competitive disadvantage if I am, myself, looking at a company in Brazil. I don't know Portuguese, for starters. I am not an expert in the way their security markets are regulated and how they operate, or how strong their banking system is. It's better for most people to leave those kinds of decisions either to money managers, through mutual funds or ETFs that are able to discern what's going on directly and then make decisions for you. Of course, they're going to charge something, and that will come out of your return

Or, what I like better: If I own Procter & Gamble, I'm going to assume that those guys know what is going on in all these different markets that they're operating in. They are going to control their risks and try to extract rewards as best as they can. Meanwhile, my dividends are paid in dollars. The financial statements are in dollars. They are under regulation and legal frameworks that I understand.

As long as the going doesn't get so rough that I have to worry about Procter & Gamble's dividend--and frankly, I can't imagine that happening at this stage--then I can have them essentially as a risk buffer. I'm still getting my dividend; in all likelihood, that dividend continues to grow. And I'll benefit from the long-term growth and their expertise that they can bring to bear in these emerging markets.

Glaser: Josh, thanks for sharing your thoughts with me today.

Peters: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.

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