Market Collision affecting Dividend Investors – Part II

In today’s post, I will discuss how El-Erian’s emerging market theme affects the dividend investors (DIs). Some of the characteristics that we DIs look for in a company are as follows:

  • Management’s sincere conviction that shareholders have stake in the business and earnings must be shared with them;
  • Dividends are paid from operating earnings;
  • Consistent growth in dividends can be maintained only if there is consistent growth in earnings; and
  • Dividend focused investing is a long term (i.e. 25-30 years) preposition.

Looking at the dividend aristocrats, one can see that they have had a pretty decent ride for the last 30-40 years on the back of growth in US economy. Along with the US economy, these companies were consistently growing their revenues (and hence the earnings). Managements consistently shared this bounty with the share holders. Now today, in general, dividend aristocrats as a group are struggling to find new source of growth in revenue and earnings. Most of the dividend aristocrats (not all of the companies) are focusing to increase earnings from internal efficiencies or cost reduction initiatives, because they are hard pressed for growth in revenue. How long this can continue? Dividend investing is long term process. Therefore, I foresee that the pool of companies in dividend aristocrat will continue to decrease.

For DIs, this is where the El-Erian’s emerging markets theme comes into play. According to the author, emerging markets will be growing faster and provide higher contribution to earnings in next 30-40 years. In that case, doesn’t it make sense to invest in dividend-based companies in emerging markets? For a moment let us think that international and emerging markets as foreign markets.

One of the issues for DIs is that there is very little public information on companies in foreign markets. If companies do not have ADRs then it is difficult, if not impossible, to find the details of such companies. Additionally, the regulatory framework and governance may not be as advanced as developed world. Here I am comparing the basic minimum requirements and not a full-proof system.

Other way to look at this is US companies or multinationals who get most of their earnings from foreign markets. Such companies have operating history, dividend payment history, management’s performance, presence in US markets, etc. Recently, there was an article on The Div-Net by Dividend Growth Investor which discussed about top 10 companies in S&P500 index and their source of earnings. This article brings out the fact that top 10 companies by weightage in S&P500 index (with approximately 22% contribution to index) derive 44% of total financial contribution from foreign markets. It is likely that if we dig deeper, we will find more such companies and this 44% contribution may even surpass 50% cumulatively for all S&P500 index companies. While we do not have the same investment vehicles as used in El-Erian’s example, the Harvard Endowment Fund, we DIs surely have US-based companies and/or multinational companies. Investing in such companies provide a very good vehicle for investing in international and/or emerging markets.

For us DIs, this is a good fit to El-Erian’s theme of long-term earnings growth in emerging markets. Also it helps us build dividend portfolio using the existing US financial infrastructure.

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