Corporate America to hike dividends to meet baby boomer demand

Vanderlee, portfolio manager at ClearBridge, says historically US corporates have been disinclined to return cash to shareholders through dividends. But with tens of millions of baby boomers beginning to retire with insufficient funds, he says American companies have been forced to change tack in the face of rising demand.

“There are around 76 million baby boomers about to retire and are doing so with insufficient savings. In addition, institutional investors such as pension plans, foundations and endowments are increasingly looking for dividend strategies to generate more income from their investments. It is already clear companies are beginning to respond to this: Microsoft, for example, recently increased its dividend by 25%. But it’s not just the giants doing this: we’re beginning to see similar moves across the board.”

Vanderlee points out that, in the second quarter of 2011, US dividend payouts were up 32.5% from the same period in 2010. That more corporates were able to pay dividends or raise them, says Vanderlee, is testament to the balance sheet repair many undertook following the 2008 crisis.

“There is lots of cash on the balance sheets of corporate America; they are the healthiest we have seen them in decades,” he says. “Large cash balances coupled with the deleveraging of balance sheets post the 2008 financial crisis afforded companies enough financial flexibility to not only raise dividends but also to improve the sustainability of those dividends. Also, many corporations are generating healthy free cash flow which provides further support for dividends.”

Yet while dividends continue to grow, Vanderlee points out that company valuations, as measured on a price/earnings basis, remain relatively depressed. “Valuations are low and attractive – we are not paying a lot to own these companies,” he says. “Longer term average S&P 500 multiples have been 17x, well above the 12x we are witnessing today, so there is an opportunity to see long-term capital appreciation as well as rising dividends.”

Although many US corporates are only now succumbing to pressure to return cash to shareholders, Vanderlee says some companies have much longer track records of increasing dividends year after year. He points to Johnson and Johnson, which has increased its dividend for 48 consecutive years, and Kimberley-Clark, which has increased dividends for the last 39 consecutive years. It is this consistency Vanderlee says will be vital for investors in the coming years.

“Rising dividends over time allows investors to factor in inflation and stay ahead of it,” he says. “This is especially important for baby boomers that need inflation protection in their retirement. What’s encouraging for them is that pay-out ratios remain low, so there is lots of room for companies to increase payouts in future. We are not at the tail end of this income phenomenon - we are at the start of it, and right now is an opportune time for investors.”