CLSA Microstrategy Dividend 2013-3-01

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Desh Peramunetilleke

[email protected] (852) 26008293

Mahesh Kedia

(852) 26008291

Shrikant Kale

(852) 26008489 1 March 2013

Global

Microstrategy

Asian dividend-wave picks Asustek (2357 TT)

Bank of China (HK) (2388 HK) China Mobile (941 HK)

IAG (IAG AU) PTT (PTT TB)

Global dividend-wave picks Itau Unibanc (ITUB4 BZ) Japan Tobacco (2914 JP) McDonald’s (MCD US) Microsoft (MSFT US) P&G (PG US) PepsiCo (PEP US)

Reckitt Benckiser (RB/ LN) Roche (ROG VX) Siemens AG (SIE GR) Toyota Motor (7203 JP) www.clsa.com

Dividend wave 2013

A global theme for all seasons

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Dividend wave 2013

We have been longstanding advocates of dividends with a singular focus on capturing total returns over the long term. We believe our persistence has paid dividends with most investors now focusing on yield as a way of enhancing returns beyond the widely held view as a barometer of safety. However, if you are yet to be convinced, we hope the case studies presented in this report will inspire you to take comfort in the concept of an asset that can appreciate while still providing distributions that exceed cash rates. This report revisits our proven approach to dividend investing through our Microstrategy ‘dividend-wave total-return portfolio’, combining dividend yields with sustainable growth to capture the best of both worlds. Our main picks, based on our dividend-wave strategy, have strong balance sheets, solid cashflow, high consensus-forecast yield and the ability to deliver the expected payout, and yet retain sufficient earnings for reinvestment to fund future dividend payments. This strategy outperformed the MSCI Asia Pacific ex-Japan index by 5.1% in 2012 and by 35% since its launch in May 2010. Our tactical call to switch out of expensive defensives into dividend-paying high-quality cyclicals ie, Shadow defensives from mid-to-end 2012 also outperformed. Further, companies with a strong track record of consistently growing dividends, our Dividend champions, have delivered 18.5% total returns since May 2012. Furthermore, emerging markets continue to be in a dividend sweetspot with depressed capex, growing cashflows and historically low gearing. Our analysis shows that last year, 88% of the MSCI Emerging Market (MSCI EM) universe paid dividends (totalling US$250bn) compared to less than half at the start of the decade. Given the slower growth environment, emerging-market high-yield stocks are developing into a new asset class poised for further rerating. China itself has come a long way from being considered as an oasis of growth to the biggest pool of cash dividends (US$77bn) in emerging markets. Indeed dividends from state-owned enterprises (SOE) have become an important topic in China’s policy agenda enhancing its sustainability. For investors, this further enhances the attractiveness of yield stocks in China, which have outperformed by 21% per annum since 2000 and 8% per annum since 2008. However, with receding global macroeconomic risks and rising interest rates on the horizon, income investors are likely to face headwinds compared with the past couple of years. But, we highlight that investors need to also take into consideration the severely depressed yields of the higher-quality fixed-income securities, which could continue to drive fund flows towards high-yield stocks. Income and absolute-return investors should also take into account the fact that top-quintile stocks within MSCI World have an average dividend yield of more than 5% and have delivered an average 1.4% return per month during periods of rising bond yields, ie, falling bond prices.

Finally, a word of caution. Like many prudent investors, we are concerned by the wider interest in dividends turning from a passion into an obsession. While the structural story in support of dividends remains intact, some investors might feel that we are already in bubble territory, given the significant rerating of high-dividend stocks over the past couple of years. Our analysis dispels this notion and suggests that only certain pockets of the high-yield universe such as defensives remain expensive, while the wider universe offers sustainable yields at attractive valuations. We encourage investors to use our seven-factor DPS revision star-rating framework to identify such inexpensive sustainable-yield stocks globally, while avoiding the value traps.

Dividends are now a way to enhance returns, not just a barometer of safety

EM dividend statistics  Total dividend-distribution of

US$250bn last year  52 companies paid more

than US$1bn each  56 companies paid more

than US$500m each  300 stocks with >3%

dividend yield

High-yield stocks underperform during rising interest rates . . . . . . but are attractive to income investors. . . . . . as they yield over 5%

and deliver positive capital gains Dividend-wave strategy combines yield with sustainable growth

Our Asian portfolio based on this strategy has outperformed consistently

Dividend-yield stocks are not in bubble territory

DPS revision star-rating framework to identify sustainable yields

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Dividends illustrated

Global overview

Dividend wave

EM, Asia high-yield stocks have done best Since 2008, high-yield best in Asia worst in Europe EM and Asian dividends have grown fastest MSCI Asia Pac ex-JP: Dividend growth will catch up

EM dividend return - Highest since 2000 Asia ex-JP: Dividend key to total returns Asian stocks do not have a debt burden Capital intensity has been falling for Asia

More companies paying dividends in EM Flows to dividend funds remain strong Asian defensives at 39% premium to cyclicals Relative PE of high-yield stocks for Asia ex-JP sectors

Source: Factset, Datastream, CLSA Asia-Pacific Markets Source: Factset, Datastream, CLSA Asia-Pacific Markets Source: Factset Alpha Tester, CLSA Asia-Pacific Markets Source: Factset Alpha Tester, CLSA Asia-Pacific Markets 0 100 200 300 400 500 600 700 800 900 1,000 D ec 99 D ec 00 D ec 01 D ec 02 D ec 03 D ec 04 D ec 05 D ec 06 D ec 07 D ec 08 D ec 09 D ec 10 D ec 11 D ec 12 Europe Asia ex JP EM DM USA (Q1 index) High-dividend-yield stocks in EM and Asia ex-JP have delivered far superior performance relative to regional peers

1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 (8) (6) (4) (2) 0 2 4 6 8 10 12 A si ax J C hi na S in g Ta iw an Ja pa n Bra zi l U SA HK A ust W or ld SAf UK Eu ro pe

Annl OPF (since 2008) Annl OPF (since 2012) Div yld (Now, RHS) Div yld (L5Y avg, RHS)

(%) (%) 50 100 150 200 250 300 350 400 450 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 AxJ Europe EM DM USA Japan DPS index rebased to 100

EM have seen highest growth among regions followed by Asia ex-JP

100 120 140 160 180 200 220 240 260 280 300 Ja n 04 Ju l 04 Ja n 05 Ju l 05 Ja n 06 Ju l 06 Ja n 07 Ju l 07 Ja n 08 Ju l 08 Ja n 09 Ju l 09 Ja n 10 Ju l 10 Ja n 11 Ju l 11 Ja n 12 Ju l 12 Ja n 13 EPS DPS Indexed FY0 value

Mind the gap, reversal is imminent (50) (20) 10 40 70 100 130 160 190 220

EM Aust AsiaxJP USA World DM Europe Japan Price return Dividend return

(%)

EM and Australia have highest dividend contribution to ther total return since 2000

(50) 0 50 100 150 200 250 300 350 D ec 00 D ec 01 D ec 02 D ec 03 D ec 04 D ec 05 D ec 06 D ec 07 D ec 08 D ec 09 D ec 10 D ec 11 D ec 12 PE EPS Dividend Currency

Contribution to US$ total return since Dec-00 (ppt)

0 20 40 60 80 100 120 140 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 _2012F _2013F _2014F AsiaxJ Europe USA Japan World (%)

Net gearing ratios are at trough levels

2 4 6 8 10 12 14 16 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 _2012F _2013F _2014F AsiaxJ Europe USA Japan World (%)

Capital intensity has been stable for USA and Europe but has been falling for Asia ex-Japan

28.0, 21.3, 26.8, 20.7 40 50 60 70 80 90 100

98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F

MSCI EM MSCI DM

(% of stocks paying dividends)

Increase in number of companies paying dividend in EM augurs well for future dividend contribution to total returns

(900) (600) (300) 0 300 600 900 1,200 1,500 1,800 05 Jan 11 02 Fe b 11 02 Mar 11 30 Mar 11 27 A pr 11 25 May 11 22 Ju n 11 20 Ju l 11 17 A ug 11 14 S ep 11 12 O ct 1 1 09 N ov 11 07 D ec 11 04 Jan 12 01 Fe b 12 29 Fe b 12 28 Mar 12 25 A pr 12 23 May 12 20 Ju n 12 18 Ju l 12 15 A ug 12 12 S ep 12 10 O ct 1 2 07 N ov 12 05 D ec 12 02 Jan 13 (US$m)

Flows in January have been strong

0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 D ec 99 D ec 00 D ec 01 D ec 02 D ec 03 D ec 04 D ec 05 D ec 06 D ec 07 D ec 08 D ec 09 D ec 10 D ec 11 D ec 12

Cyclicals Defensives Financials 12M-fwd PE (rel to region, x)

Defensives are trading at 39% permium to cyclicals versus the historical average of just 15% since 2000 0.2 0.6 1.0 1.4 1.8 2.2 C S ( x FB T) H ealth ( L1) D iv f in Te le co m Tra ns po rt R et ai l FBT A ut os C on s sv cs Mate rials U tilit ie s Pr op ert y C ap go ods S em is Te ch H W C ons d ur En erg y B an ks (x) 3.6 2.5 Current LT avg Peak Trough

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Investment highlights

Economic cycles have a significant impact on the performance of dividend-yield strategies. In the graphic below we show a normal economic cycle based on the OECD definition. Our studies show that high-yield stocks usually underperform only during the “expansion” phase of the cycle. However, dividend investors can take comfort that when combined with other factors, dividend-yield strategies can outperform in every economic cycle.

Microstrategy global dividend-yield-cycle strategy

Source: Factset Alpha Tester, CLSA Asia-Pacific Markets

However, for investors that have a longer-term view, we recommend our through-the-cycle dividend-wave strategy that aims to capture the best total returns by mixing sustainable yields with growth. The stocks in our dividend-wave portfolio have high consensus 12-month-forward yield (average yield of 4%), high sustainable growth, strong balance sheets, solid cashflow, strong DPS revision star-rating and the ability to deliver the expected payout and yet retain sufficient earnings for reinvestment to fund future dividend payments. On the next page we present the top-25 stocks by market cap from our Asian and global dividend-wave portfolio, which we plan to rebalance quarterly.

Microstrategy - Dividend-wave strategy

Source: CLSA Asia-Pacific Markets

OECD cycle (above 100)

OECD cycle (below 100)

OECD definitions:

Slowdown: Below 100 and downward sloping Recovery: Below 100 and upward sloping

Expansion: Above 100 and upward sloping Downturn: Above 100 and downward sloping

Dividend-wave strategy

Dividend wave criteria

Wave 1 Market cap >US$4bn (US$1bn for Asia) 3M ADTO >US$5m

(US$1m for Asia) Wave 2 Dividend yield >3% (>2% for US/Japan) Sustainable growth >5% (>3% for Japan) Wave 3 DPS star rating >=4 Net gearing <60%

(only for EM) Payout <60% (only for EM)

Note that a few exceptions apply to these stock selection criteria Dividend-yield strategies can outperform across economic cycles

PE and earnings certainty are two key factors for a cycle-switching strategy

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Asia and global dividend-wave stock picks (large cap picks, sorted by dividend yield)

Code Name Cty Sector Mkt cap

(US$m) (12MF, Div yld %) Star rating1 _{PE (x)}12MF 13-14F _EPS Cagr (%) Sustg (%) 13-14F ROE (avg, %) Payout (FY1, %) Gearing (FY0, %) Years of DPS cuts out of total Asian dividend-wave stock picks

177 HK Jiangsu Expway CN Transport ANZ AU ANZ Bank AU Banks 2357 TT Asustek TW Tech HW 939 HK CCB CN Banks 211,181 IAG AU IAG AU Insurance 880 HK SJM HK Cons svcs TLKM IJ Telkom ID Telecom 2388 HK BOC (HK) HK Banks LEI AU Leighton AU Cap gds 033780 KS KT&G KR FBT 5 HK HSBC HK Banks 206,771 RECL IN Rural Electrification WOW AU Woolworths AU Food&drug UMWH MK UMW MY Autos 941 HK China Mobile PGAS IJ Perusahaan Gas ID Utilities PTT TB PTT TH Energy 1088 HK Shenhua CN Energy BBL TB Bangkok Bank TH Banks UOB SP UOB SG Banks ONGC IN ONGC IN Energy SCI SP Sembcorp Ind SG Cap gds ASII IJ Astra Intl ID Autos MER PM Meralco PH Utilities 270 HK Guangdong Inv CN Utilities Global dividend 5,275 5.6 4/7 12.8 9.2 4.0 13.4 76.2 25.9 0/14 77,759 5.5 4/6 12.1 4.5 5.0 14.9 66.2 nm 1/18 9,037 5.4 5/7 11.3 7.5 6.6 17.7 56.3 (43.3) 3/12 5.1 4/6 6.7 5.9 13.5 19.0 34.3 nm 1/6 11,054 5.0 4/6 12.5 21.2 5.1 18.3 60.2 nm 3/11 14,798 4.9 6/7 15.0 12.0 9.8 35.8 74.0 (100.3) 0/3 19,709 4.9 5/7 13.2 9.7 8.8 24.7 61.3 14.9 5/17 36,745 4.8 5/6 13.1 7.0 5.7 14.8 62.8 nm 1/9 7,880 4.7 4/7 13.0 20.0 4.0 19.5 53.8 32.1 3/14 9,097 4.4 4/7 12.3 0.1 8.3 15.6 54.3 (14.5) 0/14 4.3 4/6 11.0 10.3 5.6 10.7 47.0 nm 2/17 IN Div fin 4,303 4.3 4/6 6.0 12.8 14.9 20.0 28.1 nm 2/9 41,765 4.2 5/7 16.8 5.7 8.0 27.5 71.0 47.8 0/16 4,569 4.2 5/7 12.8 10.8 9.4 21.1 54.5 (0.3) 6/15 CN Telecom 222,259 4.0 6/7 11.0 1.2 10.0 16.2 43.7 (46.9) 0/9 11,907 3.9 5/7 13.9 10.6 16.7 35.2 55.8 (4.4) 3/9 34,144 3.9 5/7 8.5 7.7 11.8 16.7 34.4 50.5 2/10 79,002 3.8 4/7 10.1 4.2 11.6 17.6 38.4 (2.2) 1/6 13,422 3.7 4/6 10.5 12.7 7.7 13.5 39.1 nm 2/10 24,568 3.6 4/6 11.3 4.0 6.8 11.5 39.3 nm 4/17 50,824 3.3 5/7 9.4 13.7 12.5 18.1 32.6 (5.6) 1/14 7,869 3.2 4/7 11.9 10.7 11.0 16.6 39.3 (23.2) 4/14 32,447 3.1 5/7 14.0 14.2 15.9 27.1 44.8 52.6 2/10 8,400 3.1 4/7 18.7 4.1 9.1 23.0 56.5 (30.9) 4/8 5,402 3.0 4/7 13.2 4.4 8.0 12.3 38.5 1.3 3/10 wave stocks (ex-Asia)

ALV GR Allianz DE Insurance 64,717 4.8 4/6 8.4 5.7 4.7 10.8 40.4 nm 2/16 BMO CN Bank of Montreal CA Banks 41,037 4.7 4/6 10.3 2.9 7.5 14.1 48.7 nm 0/17 BATS LN British American GB FBT 102,487 4.5 7/7 14.6 9.5 17.3 52.3 64.9 98.3 2/17 LKOH RM Lukoil RU Energy 50,804 4.3 4/7 4.6 2.4 12.0 13.5 19.4 9.1 1/13 NDA SS Nordea Bank SE Banks 44,353 4.2 4/6 10.5 8.5 6.7 11.5 43.9 nm 2/13 SIE GR Siemens DE Cap gds 92,477 4.2 5/7 11.7 15.1 9.6 17.0 51.6 19.8 2/18 RY CN RBC CA Banks 89,852 4.0 5/6 11.6 6.7 9.6 18.4 46.3 nm 0/18 ROG VX Roche CH Pharma 190,796 3.9 7/7 13.6 8.2 34.8 58.4 52.8 70.0 0/16 BAS GR BASF DE Materials 93,082 3.9 5/7 11.8 9.9 11.9 19.4 48.3 45.5 2/17 SU FP Schneider Elec FR Cap gds 41,159 3.5 4/7 13.0 9.7 7.2 12.9 45.8 29.2 4/17 NESN VX Nestle CH FBT 226,320 3.5 6/7 17.3 8.3 6.8 18.3 61.0 nm 0/17 UNA NA Unilever NL FBT 114,548 3.5 5/7 17.0 8.3 11.6 29.4 59.3 31.0 4/17 MCD US McDonald's US Cons svcs 95,671 3.4 6/7 16.0 8.8 19.0 41.7 54.8 nm 0/17 MSFT US Microsoft US Software 229,866 3.4 5/7 9.2 7.5 25.2 29.8 31.9 (77.0) 0/9 ITUB4 BZ Itau Unibanc BR Banks 78,025 3.3 4/6 9.9 12.2 13.9 18.7 32.3 nm 2/14 JNJ US JNJ US Pharma 204,208 3.3 5/7 13.9 6.3 12.2 21.6 45.8 nm 0/17 PG US P&G US HPC 205,311 3.1 6/7 17.9 6.7 8.2 17.7 55.8 39.9 0/18 PRU LN Prudential GB Insurance 38,826 3.1 5/6 12.1 10.1 10.9 17.7 37.8 nm 1/17 PEP US PepsiCo US FBT 112,480 3.1 6/7 16.5 7.9 15.6 30.9 51.3 108.5 0/17 RB/ LN Reckitt Benckiser GB HPC 48,913 3.0 6/7 17.2 1.6 14.4 28.1 52.2 40.2 0/17 UPS US UPS US Transport 75,484 2.9 5/7 16.3 12.4 38.0 95.5 48.3 nm 0/11 EMR US Emerson US Cap gds 41,371 2.9 6/7 15.5 8.7 13.1 23.9 45.6 28.4 0/18 2914 JP Japan Tobacco JP FBT 59,407 2.8 7/7 14.3 13.1 12.8 20.8 36.6 3.6 0/17 CSCO US Cisco System US Tech HW 109,247 2.7 5/7 10.2 6.6 15.3 18.0 28.3 (63.2) 0/1 7203 JP Toyota Motor JP Autos 151,472 2.1 4/7 12.3 25.7 5.4 10.7 26.1 85.9 2/17 1_{For details of star rating factors, please refer to appendix 7. Source: Factset, CLSA Asia-Pacific Markets}

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Summary of case studies and screens

In this report we discuss some of the key issues faced by dividend-focused investors in the current low-growth and low-interest-rate environment. Below we present a summary of the 15 most relevant questions addressed in this report.

Q1. What will be the impact of rising interest rates?

Conventional wisdom suggests that dividend-yield strategies underperform during a rising interest-rate environment. But investors need to realise that interest rates are at an all-time low, while dividend yields are still much higher than the sovereign-bond yields. Also, our backtests show that the return of the highest-yield quintile averages 1.4% per month during rising bond-yield periods while bond prices are falling, making them very attractive for income and absolute return funds. The corporate-bond market does offer higher yields but the yield compression post GFC has ensured that for a 5% yield, investors need to invest in lower-quality “B” or “C” rated bonds.

Q2. Are high-yield stocks still low risk (beta)?

There is a growing perception that the quality aspect of high-yield stocks has taken a hit and a number of high-yield stocks are high-beta cyclicals that have corrected and have unsustainable dividends. Our study suggests that dividend-yield stocks still tend to be low beta and well suited to the current uncertain and low-growth economic environment. We also highlight that stocks with 4-5% yield have the lowest beta rather than dividend-yield stocks with more than 7% .

Q3. Can dividend strategies work for Chinese stocks?

While China has been a key growth market in the region, investors have underestimated its importance from a dividend perspective. China is the largest dividend paying market in Asia ex-Japan and high-yield stocks have outperformed by almost 21% pa since 2000 and 8.1% pa since 2008. With the Chinese government taking steps to institutionalise dividends, we believe that dividends are a structural story in China.

Q4. Why focus on dividends in emerging markets?

Dividend-yield strategies have worked across most regions and markets over the past decade, though the performance in emerging markets has been significantly better. Highest-yield stocks have underperformed in Europe since the GFC but have worked well in developed markets such as the USA and Australia over the last couple of years. Among major equity markets, China has witnessed the best outperformance since 2000, while Asia ex-Japan has witnessed the best performance among regions.

Q5. Are dividends only for crisis periods?

Our analysis of the high-yield stocks during the different economic cycles suggests that dividend yields underperform only during the “expansion” phase of the cycle. This is along expected lines as investors are looking for growth and value ideas during the market run-up. However, when combined with low PE, dividend-yield strategies can outperform even during the expansionary phase. With Asia in the recovery phase as per the OECD leading indicator, we expect dividends yields to outperform on its own.

Pages 30-38 Dividend-yield stocks have strong positive absolute returns while bond prices fall

Pages 39-46

Pages 47-50

Pages 51-58

Pages 59-64 Stocks with 4-5% yield have the lowest beta as opposed to those with more than 7% yield

China has witnessed one the best performances by a high-yield strategy

EM-dividend-yield performance has been much better than DM

Dividend yields only underperform during the “expansion” phase Key issues

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Q6. Aren’t high-yield stocks overvalued?

Rerating of dividend-yield stocks has been a structural trend underpinned by the low-growth environment and sustained yield compression in the developed-world bonds. The impact of rerating hasn’t been universal to all high-yield stocks with quintile-1 stocks rerating the most in the USA while quintile-2 stocks have rerated the most in Asia. Also, we highlight that the highest quality, defensive dividend-yield stocks have rerated the most but the cyclical and financial stocks still have value, such as the global energy sector and Asian banking sector.

Q7. Does higher payout translate into higher PE?

In a perfect world the only way companies can create value for shareholders is by investing in positive NPV projects. Corporate actions such as increasing payouts should not have an impact on valuations. However, we find that companies who can still maintain their growth curve can rerate by increasing payouts. We also show that for every 10ppt increase in payout ratios, implied growth is lower by about 1ppt but the beta also reduces, thus countering the effect of slower growth. Based on this analysis, we highlight a list of stocks that can rerate by increasing their payouts by an extra 10ppts. Also see our Apple case study (pages 74-75).

Q8. Will the fund flows continue to be strong into dividend strategies?

We highlight that fund flows into dividend funds remain strong, even this year, with markets having started on a more positive note. We also note that the equity inflows have outpaced bond inflows so far. Our analysis of the pension-fund data further highlights that the shift to equities is a structural trend. We find that pension funds have significantly higher returns assumptions than actual returns and given the low-bond yields, equities stand to gain increased allocation from the lower allocation levels since the GFC. Q9. How to identify sustainable dividends?

In our Dividend wave 2012 report we highlighted the dividend life-cycle and the characteristics of stocks that increase or cut dividends over the longer term. But investors primarily focus on the consensus estimate of future dividends when analysing a stock. Hence, we developed a seven-factor DPS revision star-rating (DRSR) scale to identify stocks most likely to witness negative DPS revisions over the next three months. Our backtests show that DRSR system can help in identifying stocks that are likely to see DPS downgrades. The stocks rated lowest on our scale had a hit rate of almost 70% over the past two years. Using this system, we provide the rating for global and Asian sectors and stocks.

Q10. Will Basel 3 weaken banks’ dividend sustainability?

The new Basel-3 guidelines aim to improve the ability of banks to absorb financial and economic shocks. It now requires banks to increase the tier-1 capital from 4% to 6% but more importantly it requires banks to hold additional buffers ranging from 2.5-5.0%. It has also made the definition of equity tighter than Basel 2. And while we understand that national regulators will have significant say in setting these limits, interpretation of the guidelines and the implementation dates, banks will be increasing equity. While Asia seems to be well placed, these tighter norms could drive payout cuts to allow capital build-up in regions such as Europe. We highlight stocks and markets with lower capital ratios, based on current definitions used by banks.

Pages 65-69 Pages 70-73 Pages 76-78 Pages 79-89 Pages 104-107 Rerating is a structural trend as bond yields are low and high-yield stocks are still cheaper

Companies can provide support to their PEs by increasing payouts; also see the Apple case study

Fund flows remain strong and are now sharing the inflows meant for

fixed income

A 7-factor DPS revision star-rating system to identify forecast DPS sustainability

Some banks likely to cut payouts to shore up capital

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Q11. What is the impact of tax on dividends?

We analysed the US tax environment and dividends in detail to understand the linkages between the two. Dividend tax in the USA has come down to just 20% from 90% in the 1950s. More importantly, the gap between capital gain and dividend tax used to be 65% in the 1950s but dividends have been taxed at the same rate since 2003. This suggests that companies have no tax related motivation when deciding between buybacks and dividends. But our analysis shows a significant increase in the number of companies paying dividends and number of equity-income funds launched since 2003. This suggests that lowering of dividend taxes did have an impact.

Q12. Will companies return the cash back to shareholders?

Globally, companies are sitting on US$4tn cash pile. Notwithstanding the fact that companies cannot run with zero cash and that some of the cash is spread across geographies with little chance of a recall, we still believe companies have a lot more cash than they need to run their operations. We analyse the cashflow, gearing and capex trends to understand the probability of this cash being returned. Our analysis suggests that Asia and the USA will increase the return of cash through dividends (Asia) and buybacks (USA). However, we believe that Europe will focus on conserving cash while Japan could plough the cash into capex and acquisitions.

Q13. Will buybacks dominate the global landscape?

Current MSCI World constituents bought-back shares worth US$490bn in 2011, of which 95% came out of developed markets such as the USA. We analyse 82,744 buyback transactions since 2007 to highlight the reasons for companies doing buybacks and to identify the characteristics of a successful buyback transaction beyond the immediate support to the share price. Finally, we note that for Asia to walk the US path, the key difference of a professional versus promoter-management team needs to be addressed.

Q14. What are the key dividend strategies to focus on?

Dividend wave is our key across-the-cycle strategy that involves mixing yield

and growth to produce the best total returns over the medium term. We do some minor tweaks to the process to tightly align the global and Asian process and have added our DRSR system to improve dividend sustainability. The backtest results show solid performance with the changed strategies. Our other key strategies include Shadow defensives, the switching strategy focusing on the higher quality dividend-paying cyclical stocks, and the ex-date strategy to capture the short-term impact of dividends around ex-ex-dates. Q15. Will dividend champions continue to outperform?

Dividend growth is a key factor in dividend-yield strategies since dividend growers provide the ability to deliver sustainable capital gains besides delivering the dividend yield. Our study highlights that dividend champions, ie, companies with growing dividends, have outperformed those with merely consistent dividends both globally and in Asia. Through our characteristics study we highlight the factors that define the dividend champions and highlight a list of stocks that meet those criteria.

Some of the other themes that we have highlighted include dividend life-cycle (pages 90-100) and impact of dividend cuts and increases (pages 101-103).

Pages 108-112

Pages 113-123

Pages 124-134

Pages 135-144

Pages 145-152 Dividends made an impact in the USA after dividend taxes were brought

down in 2003

US$4T of cash, CF/BS analysis suggests increased payout in Asia and the USA

We highlight the characteristics of buybacks that drive stock outperformance

Dividend wave is the key strategy along with shadow defensives and ex-dates

Dividend growth is a long term theme and dividend champions have done well

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Key diagnostics screens and other portfolios in the report

Below is the list of other diagnostics screens and portfolios presented in this report based on the key issues mentioned earlier.

Description and criteria used for other screens and portfolios

Topic Page Screen name and description

1. Interest rates and yield 38 Stocks with dividend yield higher than bond yields

Universe MSCI World stocks with publicly traded A-rated corporate bonds of maturity more than five years

Criteria 12-month forward dividend yield > bond yield of the company’s A-rate bond

2. Yield and beta 46 Defensive stocks as highlighted by their low risk (beta) and high yield

Universe MSCI World stocks with market cap greater than US$5bn

Criteria a) Observed beta (three-year weekly) < 0.5; b) Dividend yield > 3.5%

3. Payout and PEs 73 Stocks with highest rerating potential if payout increases by 10ppts

Criteria a) Next two-year average payout between 10-50%; b) Net gearing <60%;

c) Positive FCF conversion (last five-year average); and d) Implied growth and beta change based on historical relationship with payout.

4. Dividend sustainability 88 Stocks with the least chance of a negative DPS revision

Criteria a) Dividend yield >2.5% for Japan and >3% for other regions; b) Seven-factor DPS revision star rating > 5.

5. Dividend sustainability 89 Stocks with the highest chance of a negative DPS revision

Criteria a) Dividend yield >2.5% for Japan and >3% for other regions; b) Seven-factor DPS revision star rating < 2.

6. Basel 3 107 Well capitalised dividend paying banks/financial companies

Universe MSCI World financial stocks

Criteria a) Company tier-1 CAR > 11%; b) Payout (average FY1-2) > 25%; and c) Equity-to-assets ratio > 3%.

7. Basel 3 107 Poorly capitalised dividend paying banks/financial companies

Universe MSCI World financial stocks

Criteria a) Company tier-1 CAR < 11%; b) Payout (average FY1-2) > 25%; and c) Equity-to-assets ratio > 3%.

8. Cash hoarders 122 Stocks with excess cash on balance sheet and strong cashflow

Criteria a) Cash to total assets > 10%; b) Solid track record of FCF > dividends; c) Robust FCF conversion (last five-year average) > 50%; and d) Net gearing < 50%.

9. Buybacks 134 Value accretive buybacks

Criteria a) High free float >60%; b) Low PE Reilly <40%; c) Cheap relative to the local MSCI index <1x; d) ROE estimate < mid-cycle ROE; e) Low net gearing <50%; and f) Positive FCF conversion (last five-year average)

10. Dividend growers 152 Global dividend champions (ex-Asia)

Criteria a) Sustainable growth > 6%; b) High earnings certainty >8x; c) Strong quality with ROEs >10%; d) Payout <60%; e) Net gearing <80%; f) Strong track record of increasing dividends in the past; and g) Strong track record of FCF > dividends.

11. Dividend growers 151 Asian dividend champions

Universe Broader list of Asia Pacific ex-Japan stocks with market cap > US$1bn

Criteria a) Sustainable growth > 5%; b) High earnings certainty >8x; c) Strong quality with ROEs >10%; d) Payout <75%; e) Net gearing <60%; f) Strong track record of increasing dividends in the past (few stocks have less history); and g) Strong track record of FCF > dividends (few stocks are now slowing capex).

12. Shadow defensives 155 Asian shadow defensives

Universe Broader Asia Pacific ex-Japan cyclical stocks with market cap > US$1bn

Criteria a) Dividend yield > 2.5%; b) High earnings certainty >10x; c) Strong quality with ROEs >10%; d) Not cut dividends more than 3/10 years; e) Cheap based on 12M PE and PB Reilly < 65%; and f) Positive FCF conversion (last five-year average)

(11)

Global dividend overview

A year ago we were discussing how the record-low bond yields for high-quality government debt have made the job of income-fund managers challenging. We suggested that such fund managers should focus on high-dividend-yielding equities, especially those from the emerging markets. That trade has worked well but now the high-yield investors face a new set of challenges, such as expensive valuations, rising bond yields, improving economic prospects and chances of encountering value traps. However, despite these concerns, we remain optimistic on high-yield strategies that look beyond the traditional defensive characteristics and focus on capturing long-term total returns.

From a macro perspective two issues matter most for any dividend-yield strategy - impact of a turn in the business cycle and the direction of the bond yields. In Figure 1 we show a normal business cycle based on the OECD definition. Our studies show that high-yield stocks usually underperform during the expansion phase of the cycle. However, we highlight in the chart that when combined with the right styles/factors, dividend-yield strategies can still outperform in every cycle. However, for those investors who have a buy-and-hold approach, we recommend our low-turnover dividend-wave strategy that delivers solid returns across the cycle.

Over the past few months, the US economy has shown some improvements and consequently US bond yields have been rising along with those of some of the other higher-quality developed markets. These rising bond yields are also a concern for yield investors as they usually coincide with underperformance of yield strategies. In a detailed analysis of the global bond versus dividend-yield relationship we highlight that even though high-yield stocks underperform, their absolute performance is still significantly positive, while during the same period, bond prices fall.

The final issue of major concern is the expensive valuations of the high-yield stocks. We find the relative rerating trend structural and that the absolute valuations are still below the overall market. We also highlight that defensives and quality yield stocks are expensive compared to cyclicals.

Figure 1

Microstrategy global dividend-yield cycle strategy

Source: Factset Alpha Tester, CLSA Asia-Pacific Markets

OECD cycle (above 100)

OECD cycle (below 100)

Slowdown: Below 100 and downward sloping Recovery: Below 100 and upward sloping

Expansion: Above 100 and upward sloping Downturn: Above 100 and downward sloping

Dividend-wave strategy New set of challenges for

dividend investors such as rising bond yields and expensive valuations

Dividend-yield strategies can outperform across economic cycles

Rerating trend structural though defensives are significantly overvalued

High-yield stocks much more attractive than bonds during rising yields

Yield and factor combinations to perform across cycles

(12)

High-dividend-yield stocks have outperformed globally

Investors should also recognise that the superior performance of high-yield stocks is not restricted to a few markets within the regions. Figure 2 shows that high-yield stocks have outperformed in most of the bigger markets since 2000. This outperformance has been most pronounced for emerging regions, particularly Asia ex-Japan, and hence our preference for high-dividend-yield stocks within emerging markets. Among the developed markets, Japan has produced the best relative returns while the high-yield Australian stocks have barely outperformed. The biggest surprise has been the significant underperformance of high-yield stocks in Europe since 2008. We believe that yield unsustainability could be a key reason behind underperformance, despite the tough market conditions.

Figure 2

MSCI regions and markets - Dividend-yield performance

Note: Backtest based on MSCI universe. Factor quintiles are rebalanced on monthly basis. Source: Factset alpha tester, CLSA Asia-Pacific Markets

High-yield’s outperformance has been supported by the relative rerating. There are concerns that high-yield stocks, especially those with the higher quality, are not cheap anymore. In Figure 3 and 4 we show the peak-to-trough of the relative PE of stocks with yield more than 3%. We find that expensive defensives are a key driver of these higher relative valuations.

Figure 3 Figure 4

High-yield1_{: Relative PE peak-to-trough (past 10 years) High-yield}1_{defensives: Relative PE peak-to-trough}

1_{Based on yield more than 3%. MSCI universe with monthly rebalancing. Defensive based on MSCI GICS Level 1 sectors.} Source: Factset alpha tester, CLSA Asia-Pacific Markets

1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 (8) (6) (4) (2) 0 2 4 6 8 10 12 C hi na A si ax J Jap an Tai w an S ing _Thai EM W or ld U SA _DM UK HK _SAf B ra zi l Lat A m Eu rop e A us t

Annualised OPF (since 2000) Annualised OPF (since 2008) Div yield (Now, RHS, %) Div yield (L5Y avg, RHS)

(%) (%) 21.3 _14.9 0.6 0.8 1.0 1.2 U SA Ja pa n A Px J Eu ro pe La tA m (x) Current LT avg Peak Trough Sorted by current versus the LT average

0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 La tA m U SA A Px J Ja pa n Eu ro pe (x) Current LT avg Peak Trough

Sorted by current versus the LT average 1.8

0.4 Expensive valuations

largely due to the defensives Asia ex-Japan has delivered the best performance High-yield stocks have outperformed globally

(13)

Dividends are important from a total-return perspective

Even for non-dividend focused investors, dividends play an important role in generating total returns. While the dividend returns look small year-on-year, their impact is significantly higher on a cumulative basis over longer periods. Figure 5 highlights the break-up of regional total returns since 2000. It highlights that emerging markets have not only delivered the best total-return performance relative to other regions, but have also witnessed the best dividend contribution. It is also important to note that the price returns in most developed markets have been negative since 2000, with only dividends contributing positively to total returns.

Figure 5

Total returns with dividends reinvested - Highest since 2000 for MSCI EM

Source: Bloomberg, CLSA Asia-Pacific Markets

Figures 6 and 7 show the breakdown of cumulative US-dollar total-return for the MSCI EM and MSCI Asia ex-Japan indices since end-2000. In these charts, the total return is disintegrated into four components: currency appreciation, reinvested dividends, forward earnings and forward PE. It is evident that reinvested dividends are the second-biggest contributor to total returns after earnings, for both the MSCI EM and Asia ex-Japan. On the other hand, forward PE is a negative contributor to returns as markets are cheap compared with end-2000 valuations. It is also interesting to note that earnings contribution hit a peak in 2007, but dividend contribution continued to grow.

Figure 6 Figure 7

MSCI EM - Disintegrating total return index MSCI Asia ex-JP - Disintegrating total return index

Note: MSCI universe. Source: CLSA Asia-Pacific Markets (50) (20) 10 40 70 100 130 160 190 220

EM Australia AsiaxJP USA AC World DM Europe Japan

Price return Dividend return (%)

EM and Australia have highest dividend contribution to ther total return since 2000

(50) 0 50 100 150 200 250 300 350 400 450 D ec 00 Jun 0 1 D ec 01 Jun 0 2 D ec 02 Jun 0 3 D ec 03 Jun 0 4 D ec 04 Jun 0 5 D ec 05 Jun 0 6 D ec 06 Jun 0 7 D ec 07 Jun 0 8 D ec 08 Jun 0 9 D ec 09 Jun 1 0 D ec 10 Jun 1 1 D ec 11 Jun 1 2 D ec 12 PE EPS Dividend Currency

Contribution to US$ total return since Dec-00 (ppt)

(50) 0 50 100 150 200 250 300 350 D ec 00 Jun 0 1 D ec 01 Jun 0 2 D ec 02 Jun 0 3 D ec 03 Jun 0 4 D ec 04 Jun 0 5 D ec 05 Jun 0 6 D ec 06 Jun 0 7 D ec 07 Jun 0 8 D ec 08 Jun 0 9 D ec 09 Jun 1 0 D ec 10 Jun 1 1 D ec 11 Jun 1 2 D ec 12 PE EPS Dividend Currency

Contribution to US$ total return since Dec-00 (ppt) Reinvested dividends

have been 40% of total returns of MSCI EM

Most developed markets have negative

price returns

Dividends are second-largest contributors to total returns after earnings

(14)

Dividend-yield performance

In Figure 8 we summarise the outperformance of different yield and payout ranges for the MSCI World. It shows that the performance has been best for the 5-7% dividend-yield stocks, while stocks with less than 2% yield have underperformed. The same is true for performance over the past one year with 5-7% yield stocks performing the best.

Figure 8

MSCI World: Outperformance for dividend yield and payout ranges

Note: MSCI-weighted total return.

Figure 9

Annualised outperformance1 _{of stocks in different-yield ranges}

Div yields <2% 2-3% 3-4% 4-5% 5-7% >7% >3%

MSCI

regions Since 2003 Last 12M Since 2003 Last 12M Since 2003 Last 12M Since 2003 Last 12M Since 2003 12M Last Since 2003 Last 12M Since 2003 Last 12M World (1.1) (1.5) 0.7 (2.3) 0.9 0.7 1.2 0.9 4.1 7.4 0.6 (5.3) 1.1 2.1 DM (0.7) (1.9) 1.0 (3.4) 1.3 2.3 0.9 0.2 3.3 8.0 (2.1) (5.3) 0.9 2.7 EM (3.0) 0.9 (2.0) 3.0 (1.9) (7.0) 4.0 4.1 8.0 5.9 na na 3.2 (0.8) Asia ex-JP (2.2) (4.2) (0.5) 1.5 1.4 (1.0) 4.9 7.7 5.5 8.2 na na 3.4 3.0 AP ex-JP (1.7) (7.2) (1.0) (1.9) 0.7 (3.7) 2.6 4.7 2.8 10.2 6.2 12.3 2.2 4.4 Asean (4.6) (8.9) (3.9) (2.4) (0.7) (4.1) 2.4 2.7 5.5 13.8 na na 2.9 2.0 Europe (1.1) (3.5) 1.9 0.4 0.4 4.3 1.3 0.3 0.6 (1.7) (5.9) (11.8) (0.3) (0.0) Latam (5.0) 17.0 (13.0) 0.6 (3.1) (3.9) 6.5 10.1 15.1 0.2 na na 5.3 (3.9) Japan (1.3) (0.2) 2.1 0.1 8.7 0.4 na na na na na na 4.0 0.8 USA (0.1) 1.3 1.1 (4.8) (0.3) 1.8 (1.0) 2.3 3.0 8.0 (0.7) (7.4) (0.1) 2.8 MSCI markets Australia na na (1.6) (11.5) 2.6 (9.4) (2.3) (6.7) (1.8) 12.5 1.2 9.9 0.0 4.0 China (2.1) (0.0) (4.1) 3.5 (2.3) (17.4) 12.1 16.8 0.5 2.1 na na 3.7 (0.7) HK (1.2) 2.6 (1.0) (0.5) 4.8 0.5 5.8 5.0 (1.3) 9.3 na na 2.8 1.6 India (4.0) (4.3) 7.6 13.1 (3.3) 1.3 na na na na na na 1.8 7.7 Indonesia na na (6.9) 2.4 (12.7) (6.8) (10.8) (7.6) na na na na (1.8) 0.5 Korea (1.2) 1.1 1.1 (5.6) (4.0) (0.4) (8.9) 1.9 na na na na (3.2) (0.0) Malaysia (6.1) (11.7) (2.4) (1.8) (0.6) (5.2) 3.0 19.9 2.1 17.5 na na 1.7 3.8 Philippines (2.7) 6.9 5.6 (1.3) na na na na na na na na 0.4 (19.8) Singapore 0.5 (15.2) (8.0) 3.2 1.5 1.1 1.4 (0.7) 6.8 11.5 na na 2.2 3.0 South Africa na na (3.3) 9.3 (7.2) (9.6) 1.5 4.4 2.5 (0.0) na na 0.7 1.2 Taiwan (10.5) (12.0) (3.7) (2.1) (0.9) 7.2 0.1 (1.2) 5.0 5.1 na na 4.4 2.8 Thailand na na na na 10.4 (9.7) (2.6) (5.6) 2.1 1.1 na na 4.1 (2.7) UK 0.6 (16.3) 1.1 (4.4) (2.4) 7.6 1.2 2.3 6.8 3.2 na na (0.1) 3.0 1 _{Annual Cagr of total returns for yield bucket - Annual Cagr of the index. We have removed current data if the historical range is not available.} Highlights show the highest score since 2003 and last 12 months. Source: Factset alpha tester, CLSA Asia-Pacific Markets

<2 2-3 3-4 4-5 5-7 >7 >3 All 0-20 (0.6) 10.0 na na na na na (0.3) 20-40 (2.1) 0.6 2.6 5.8 18.1 na 3.9 0.2 40-60 (0.6) 1.8 (0.0) 1.7 0.2 na 0.0 0.0 60-80 na (1.9) 0.6 2.2 6.0 0.1 1.9 1.5 >80 na na (0.2) (0.9) 3.6 2.3 0.9 0.5 All (1.1) 0.7 0.9 1.2 4.1 0.6 1.1 0.0 <2 2-3 3-4 4-5 5-7 >7 >3 All 0-20 1.4 (7.0) na na na na na 1.3 20-40 (6.1) (3.9) (0.8) (3.1) 8.9 na 0.7 (3.2) 40-60 2.8 6.9 1.3 6.3 0.1 na 2.9 3.8 60-80 (14.0) (0.5) 0.9 2.0 8.9 1.7 4.0 3.4 >80 (19.9) (4.3) 0.5 (3.5) 11.4 (8.8) (0.9) (1.6) All (1.5) (2.3) 0.7 0.9 7.4 (5.3) 2.1 0.0 Annualised OPF

since 03 (%) Dividend-yield ranges (%)

P ay o u ts Last 1-year

OPF (%) Dividend-yield ranges (%)

P

ay

o

u

ts

Over the past 10 years, 5-7% yield stocks have delivered the best returns

Stocks with yield less than 2% have underperformed

(15)

Dividend-payout performance

In Figure 10 we summarise the outperformance of different payout ranges for the key region and markets. It shows that over the past one-year performance has been best for the 40-60% payout stocks within the MSCI World while stocks with more than 80% payouts have underperformed. However, for the long term, stocks with >60% payout have outperformed. Figure 10

Annualised outperformance of stocks in different payout ranges

Div yields <20% 20-40% 40-60% 60-80% >80% >40% >60% MSCI

regions Since 2003 Last 12M Since 2003 Last 12M Since 2003 Last 12M Since 2003 12M Last Since 2003 Last 12M Since 2003 Last 12M Since 2003 Last 12M World (0.3) 1.3 0.2 (3.2) 0.0 3.8 1.5 3.4 0.5 (1.6) 0.3 2.9 1.3 1.6 DM (0.0) 1.5 0.1 (3.1) 0.3 3.8 1.5 2.0 0.1 (2.0) 0.4 2.6 1.1 0.6 EM (1.3) 1.0 0.6 (2.4) (0.2) 0.7 0.6 13.9 1.2 0.8 0.1 3.4 0.5 7.2 Asia ex-JP 0.5 (2.9) 1.3 (0.1) 1.1 1.6 (0.5) 7.6 2.7 0.0 0.8 2.1 0.6 3.5 AP ex-JP (0.1) (5.1) 2.1 (4.8) 1.4 0.3 1.1 11.1 0.3 7.2 0.8 5.7 0.6 9.8 Asean 4.1 (10.1) 0.7 (2.5) (1.3) (2.1) 4.9 0.3 (1.0) 14.4 (0.2) 1.4 1.5 8.3 Europe 0.3 (5.5) 1.1 1.4 (0.1) 3.4 (2.1) (3.7) 2.3 (7.2) (0.4) 0.3 (0.9) (5.2) Latam 1.3 17.9 (1.2) (6.3) (3.4) 2.7 0.8 21.9 4.6 13.8 (0.5) 9.8 2.8 17.0 Japan (1.6) (0.2) (0.9) 2.2 4.3 (2.5) 0.6 9.6 5.5 (6.2) 3.7 (1.1) 0.8 (0.6) USA 0.8 4.9 0.7 (4.6) (0.5) 2.8 2.7 (1.5) (5.3) 1.8 (0.4) 1.8 0.4 (0.5) MSCI markets Australia (9.3) (38.4) 4.7 (26.8) (1.6) (6.6) 0.6 9.8 (2.3) 13.3 (0.5) 7.5 (0.4) 10.5 China 5.3 12.3 (0.8) (1.7) 3.5 (8.3) 7.1 4.2 na na 2.9 (6.5) 6.7 3.2 HK (6.7) 32.7 1.9 8.1 1.6 (6.5) (4.4) (1.4) 4.9 (3.9) 0.9 (4.9) (0.3) (3.4) India (2.8) (1.5) 5.7 (3.4) 8.5 29.5 (9.5) na na na (2.2) 24.0 (19.3) 5.4 Indonesia (2.3) na 4.4 4.4 (8.1) (1.6) na (23.2) na na (7.0) (1.5) na (0.2) Korea 0.9 0.3 (3.8) (6.0) 1.1 5.1 na na na na 1.4 7.0 na 0.1 Malaysia (2.9) (12.3) (4.0) (1.2) 2.9 (4.3) 6.4 7.5 (1.4) 16.5 1.8 2.8 2.3 11.9 Philippines na (0.0) (1.3) 15.4 (4.7) (1.7) na na na na (1.7) (13.2) na na Singapore 0.3 0.6 (5.3) (13.7) 0.5 5.1 9.3 (0.9) 1.7 13.7 1.6 5.6 3.9 6.0 South Africa na na (1.7) (7.6) (0.7) 2.5 0.8 14.3 na na (1.0) 6.7 (2.4) 12.8 Taiwan (2.9) (7.4) (3.1) (3.7) 1.6 8.9 0.4 10.4 9.7 (9.7) 3.7 2.6 4.0 (2.3) Thailand na na 3.9 (8.7) (2.7) (1.0) 18.1 na (7.3) 31.4 0.9 11.2 4.6 26.9 UK 5.2 (13.6) 2.7 (1.1) (0.4) 8.2 0.2 2.0 1.1 (2.8) (0.2) 5.0 0.9 (0.1) Note: We have removed current data if the historical range is not available. Highlights show the highest score since 2003 and last 12 months.

Figure 11

MSCI World: Number of companies under dividend yield and payout ranges

Note: Median of monthly values since 2003. Source: Factset alpha tester, CLSA Asia-Pacific Markets <2 2-3 3-4 4-5 5-7 >7 >3 All 0-20 502 31 8 2 1 0 12 570 20-40 298 204 93 35 17 3 150 698 40-60 36 105 132 92 53 9 302 449 60-80 8 19 40 57 66 15 181 209 >80 9 12 19 28 54 42 151 172 All 851 400 299 221 192 67 774 2132 <2 2-3 3-4 4-5 5-7 >7 >3 All 0-20 483 41 7 1 2 0 10 534 20-40 306 284 103 43 10 2 158 748 40-60 43 132 151 92 33 5 281 456 60-80 6 22 42 63 66 11 182 210 >80 13 29 41 42 65 41 189 231 All 851 508 344 241 176 59 820 2179 Count of stocks

(since 2003) Dividend-yield ranges (%)

P ay o u ts P ay o u ts Count of stocks

(current) Dividend-yield ranges (%)

Enough stocks available in different payout and yield ranges Higher payouts outperform for MSCI World while for Asia lower payouts outperform

(16)

Global dividend yield and payout trends

Dividend yield for MSCI EM stands at around 2.9%. While this may look small compared with the 3.9% yield on offer from MSCI Europe, it is important to note that the sustainability of dividends yields is higher, given the macro risks in the Euro-region. Indeed, emerging-market dividend yields were at par with Europe until 2005. However, a liquidity-driven rally in 2006-07 led to the rerating of emerging-markets stocks and a related fall in yields. Since then, the relative gap has persisted but became acute due to weak EU economy. US dividend yields are the lowest but the payouts are masked by buybacks, which have been higher than dividends on average over the past decade. So from a total-yield perspective, US yields and payouts are significantly larger. Figure 12

Dividend yields for USA, Europe and EM

Source: Bloomberg, CLSA Asia-Pacific Markets

Emerging markets have been paying out in the 35-40% range over the past decade, although during severe crises nominal payout ratios move above 50%, led by fall in earnings. However, with falling capital intensity and lower gearing levels, emerging markets are well placed to increase payouts and deliver higher yields on a sustained basis.

Figure 13

Payout ratios for USA, Europe and EM

Source: Bloomberg, CLSA Asia-Pacific Markets 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

MSCI EM MSCI Europe MSCI US

(%)

EM yields have tracked well with Europe until 2005, but are diverging since then

Current 0.9ppt-gap is largely price driven with Europe falling behind on recovery

25 30 35 40 45 50 55 60 65 70 75 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

MSCI EM MSCI Europe MSCI US

(%) EM yields lower than

Europe but more sustainable

US yields are masked by significant buybacks

Falling capital intensity, low gearing could lead to higher payouts in EM EM dividend payout has been in the 35-40% range

(17)

Dividend-yield quintile trends

While the overall dividend-yield trend seems to range between 2-5% globally, there are enough stocks available to investors across the wide spectrum. The highest-dividend-yield quintile stocks have had an average dividend yield of over 5.5% during the past 10 years. Even now the average yield of the highest-quintile stocks is 5.3%. Indeed from a snapshot perspective, the current average dividend yield of the different quintiles matches closely with that of the past 10-year average for the MSCI World universe.

Figure 14

MSCI World: Weighted average dividend yield of different quintiles

Note: Bottom-up aggregated using MSCI weights. Source: Factset alpha tester, CLSA Asia-Pacific Markets

The changes to the highest-quintile dividend-yield trends are best witnessed through the region-wise analysis. In Figure 15 we show the average dividend yield of the highest quintile stocks within each of the major regions since 2003. The chart shows that the average yield of Japanese Q1 stocks exceeded that of the USA in 2012 before starting to fall as Japanese equities rallied. Similarly, it is interesting to note that Asian and European Q1 yields have swapped ranks since GFC.

Figure 15

MSCI regions: Weighted-average dividend yield of Q1 stocks since 2003

Note: Bottom-up aggregated using MSCI weights. Source: Factset alpha tester, CLSA Asia-Pacific Markets 5.7 3.6 2.4 1.4 0.4 5.3 3.4 2.4 1.6 0.4 0 1 2 3 4 5 6

Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 Average (since 2003) Now Average dividend yield (%)

1 2 3 4 5 6 7 8 9 10 D ec-02 M ay -03 Oc t-03 M ar -04 A ug-04 Ja n-05 Ju n-0 5 N ov -0 5 A pr -0 6 S ep -0 6 Fe b-07 Ju l-0 7 D ec-07 M ay -08 Oc t-08 M ar -09 A ug-09 Ja n-10 Ju n-1 0 N ov -1 0 A pr -1 1 S ep -1 1 Fe b-12 Ju l-1 2 D ec-12

APxJ Europe USA Japan

Average dividend yield (%) Current average yield of

different quintiles is comparable to the long-term average Highest quintile stocks have an average yield of well over 5%

Europe offers the highest yield but also underperformed the most Japanese Q1 stocks had higher yield than those in the USA in 2012

(18)

Figure 16

Weighted-average dividend yield of stocks in different quintiles

Dividend yields Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5

MSCI regions L10Y

Average Now Average L10Y Now Average L10Y Now Average L10Y Now Average L10Y Now

World 5.7 5.3 3.6 3.4 2.4 2.4 1.4 1.6 0.4 0.4

Developed markets 5.5 5.3 3.4 3.4 2.3 2.4 1.3 1.6 0.3 0.4

Emerging markets 6.8 5.3 4.1 3.6 2.9 2.5 1.8 1.7 0.8 0.7

Asia ex-Japan 5.8 4.8 3.9 3.4 2.8 2.4 1.8 1.7 0.8 0.7

Asia Pac ex-Japan 6.3 5.4 4.3 3.6 3.1 2.6 2.0 1.7 0.8 0.7

Asean 6.3 5.2 4.5 3.8 3.6 3.0 2.5 2.2 1.1 1.3 Europe 6.2 6.5 4.4 4.5 3.3 3.4 2.4 2.4 1.2 1.3 Latin America 8.4 5.3 4.7 3.5 3.4 2.5 2.0 1.6 0.9 0.9 Japan 2.8 3.4 1.9 2.3 1.6 1.9 1.2 1.4 0.7 0.9 USA 4.4 4.1 2.5 2.7 1.5 1.8 0.7 0.8 0.1 0.0 MSCI markets Australia 7.5 6.5 5.9 5.5 4.8 4.5 3.5 3.3 2.0 2.1 China 4.9 4.5 3.5 3.0 2.7 2.1 2.0 1.6 1.0 0.7 Hong Kong 5.5 4.6 4.3 3.8 3.3 2.8 2.6 2.3 1.5 1.5 India 3.7 2.8 2.3 1.9 1.7 1.5 1.1 1.0 0.6 0.3 Indonesia 5.8 4.8 4.2 3.2 3.4 2.4 2.7 2.1 1.3 1.7 Korea 4.8 3.9 2.9 2.3 2.0 1.4 1.4 0.8 0.5 0.5 Malaysia 6.4 5.1 4.6 3.9 3.5 3.2 2.4 2.6 1.1 0.8 Philippines 6.4 5.6 3.3 2.3 2.1 1.6 1.4 1.2 0.7 0.9 Singapore 6.1 5.7 4.5 4.3 3.6 3.5 2.5 2.4 1.1 1.3 South Africa 7.1 6.1 5.2 4.5 4.5 3.8 3.5 2.7 1.9 1.3 Taiwan 7.0 5.4 5.1 4.4 3.9 3.2 2.7 2.4 1.2 1.5 Thailand 7.4 5.2 5.4 4.0 4.5 3.6 3.5 2.8 2.4 1.9 UK 6.2 5.6 4.6 4.3 3.6 3.3 2.8 2.6 1.4 1.5

Note: Aggregated using MSCI weights. Source: Factset alpha tester, CLSA Asia-Pacific Markets

In Figure 17 we also show the median size of stocks in the different yield and payout ranges. The table highlights that lower yield stocks tend to be slightly bigger companies, with 3-4% range having the peak market cap. On the other hand, stocks with more than 7% yield are those that have probably corrected a lot or do not have the ability to grow.

Figure 17

MSCI World: Median market cap of stocks under dividend yield and payout ranges

Note: Median of monthly values since 2003. Source: Factset alpha tester, CLSA Asia-Pacific Markets

<2 2-3 3-4 4-5 5-7 >7 >3 All 0-20 6.2 5.4 na na na na na 6.1 20-40 6.0 6.3 6.1 4.0 3.5 na 5.6 6.1 40-60 5.3 8.0 8.0 7.6 5.2 na 7.0 7.2 60-80 na 4.7 5.8 6.0 5.2 5.0 5.6 5.5 >80 na na 5.4 4.8 4.7 3.9 4.6 4.7 All 6.1 6.3 6.8 5.9 4.9 3.8 5.7 5.9 <2 2-3 3-4 4-5 5-7 >7 >3 All 0-20 8.0 10.8 na na na na na 8.2 20-40 8.2 9.0 7.8 12.8 9.6 na 8.6 8.6 40-60 7.5 8.5 10.2 11.9 10.7 na 10.7 9.7 60-80 11.6 5.1 8.2 10.6 10.2 11.4 9.6 9.0 >80 7.3 9.7 7.2 6.0 6.9 5.8 6.5 6.7 All 8.0 8.9 8.9 9.7 8.6 6.6 8.9 8.5 P ay o u ts Mkt cap

(US$bn) Dividend-yield ranges (%)

P ay o u ts Mkt cap

(US$bn) Dividend-yield ranges (%)

In market-cap terms, 2-5% yield stocks tend to be bigger

Stocks with more than 7% dividend yield are smaller due to limited growth options

(19)

High yield = High payout

Earlier in this section we had highlighted that 40-60% payout range stocks have outperformed most over the past one year. In Figure 18 we compare the current average payout of different yield ranges to that over the past 10 years. It shows that the stocks with the ideal payout range for performance fall in the 2-5% range.

Figure 18

MSCI World: Current payout versus average since 2003 for dividend yield ranges

Note: Payout is bottom-up aggregated using median values.

Figure 19

Weighted average payout of stocks in different yield ranges

Div yields <2% 2-3% 3-4% 4-5% 5-7% >7% >3%

MSCI

regions L10Y

1_Now _L10Y1_Now _L10Y1_Now _L10Y1_Now _L10Y1_Now _L10Y1_Now _L10Y1_Now World 19.1 19.2 38.4 38.9 47.8 50.8 57.5 59.0 67.1 72.3 78.8 85.3 57.9 60.3 DM 19.3 19.2 40.4 39.2 50.6 52.0 60.5 61.7 71.6 73.1 84.3 88.3 61.0 62.1 EM 18.0 19.3 32.9 38.1 41.8 48.4 50.1 53.7 60.3 70.1 75.3 na 53.4 56.7 Asia ex-JP 19.1 19.7 34.7 39.5 44.4 48.5 54.8 56.5 65.2 75.9 74.9 87.6 55.0 56.2 AP ex-JP 19.1 20.1 36.4 40.2 47.0 49.6 58.3 59.0 68.9 78.5 80.0 89.5 59.6 60.2 Asean 21.4 27.0 36.9 39.3 48.0 52.9 58.9 65.7 70.4 93.1 82.5 na 60.9 63.7 Europe 19.9 22.4 38.9 35.5 47.6 47.2 55.9 55.3 65.3 66.5 78.7 78.6 56.7 58.4 Latam 22.0 27.7 34.3 43.7 41.4 60.6 48.4 56.8 59.2 59.4 77.9 na 56.9 63.3 Japan 24.8 28.5 40.6 43.2 53.2 51.3 60.3 55.1 65.9 na 44.8 na 57.5 52.2 USA 12.6 12.5 38.5 35.8 50.9 54.2 63.7 67.8 76.2 74.4 90.7 99.4 60.2 62.5 MSCI markets Australia 22.1 35.8 47.2 48.4 59.1 58.1 67.6 65.3 78.2 81.2 87.8 91.3 74.5 73.0 China 21.8 21.2 34.7 34.2 39.8 32.4 44.6 37.7 48.5 50.2 52.2 na 43.8 37.2 HK 25.0 28.8 42.7 43.5 55.3 61.6 62.9 57.9 67.1 83.6 68.9 na 61.9 62.6 India 18.0 17.7 32.3 41.1 44.9 25.2 45.0 na 40.4 na 41.7 na 46.1 25.5 Indonesia 17.6 29.5 36.8 41.5 43.3 44.3 48.1 58.9 47.0 85.7 50.9 na 47.5 55.0 Korea 13.0 12.9 25.0 26.1 28.8 24.9 35.9 39.7 45.9 na 66.6 na 35.5 36.4 Malaysia 18.3 17.6 35.9 39.0 54.7 48.5 66.3 78.2 78.2 86.4 93.0 na 69.0 65.0 Philippines 23.6 29.1 34.7 34.2 45.0 41.2 63.8 na 59.7 na 91.4 na 63.2 75.9 Singapore 23.0 30.2 37.1 33.0 49.4 51.5 67.8 71.2 88.3 100.0 100.0 na 68.5 67.1 South Africa 18.3 16.4 36.7 47.4 41.0 44.6 47.6 53.4 58.5 78.9 76.0 na 51.7 56.9 Taiwan 22.3 23.4 37.0 50.0 47.9 63.9 58.2 63.8 66.6 74.8 72.2 na 61.3 66.6 Thailand 10.6 38.0 34.4 44.4 39.7 65.1 48.4 40.8 59.8 100.0 74.4 na 53.1 59.3 UK 22.5 23.9 41.2 36.6 47.7 49.9 54.7 58.7 63.6 57.5 76.7 89.4 54.4 56.1 1 _{Median value over the past 10 years. Source: Factset alpha tester, CLSA Asia-Pacific Markets}

0 10 20 30 40 50 60 70 80 90 0-2 2-3 3-4 4-5 5-7 >7

Dividend yield range (%)

Median since 2003 Current FY1 payout (%)

Reasonable payout range 40-60% More than 7% stocks are

ex-growth as payout is over 80% Stock with 2-5% yield have the ideal payouts

(20)

Improving dividend statistics for emerging markets

It may be surprising, but a larger proportion of emerging-market companies in the MSCI universe paid dividends last year than their developed-market peers. Only 45% of emerging-market companies paid dividends back in 1998, but that number has now increased to 88%. Also, 52 companies accounted for US$147bn, with each paying over US$1bn, out of the US$250bn that MSCI EM companies paid last year as dividends. Another 56 companies paid US$39bn, with each paying more than U$500m. Figure 21 shows the breakdown by market. MSCI EM stocks have managed a DPS Cagr of 13.7% since December 2000. We believe that, given low payouts and sufficient cashflows, this growth rate can be sustained and will result in the MSCI EM companies paying more than US$5.4tn over the next decade.

Figure 20 Figure 21

More companies paying dividends in MSCI1_EM _{MSCI EM paid US$250bn of dividends in 2011}2

1_{Using MSCI universe as it existed in the past.}2_{Most companies have not reported 2012 results. Source: Factset, CLSA Asia-Pacific Markets}

Our analysis shows that 39% of MSCI EM companies have a 12-month forward dividend yield of more than 3%, while the same ratio for MSCI World is 37%. This statistic highlights that emerging markets offer better high-yield opportunities than developed markets. No doubt the high dividend-yield opportunity is attractive in this low bond-yield environment. However, investors must focus on dividend sustainability to capture the best total returns, especially as the bond yields increase in developed markets.

Figure 22

MSCI World: Number of companies under dividend yield and payout ranges

Source: Factset alpha tester, CLSA Asia-Pacific Markets 40 50 60 70 80 90 100

98A 99A 00A 01A 02A 03A 04A 05A 06A 07A 08A 09A 10A 11A 12F

MSCI EM MSCI DM (% of stocks paying dividends)

Increase in number of companies paying dividend within EM augurs well for future dividend contribution to total returns 0

10 20 30 40 50 60 70 80 90 EM C hi na Bra zi l Ta iw an Ind ia R us si a K or ea Malay sia Me xic o C hile Tha ila nd S . Af ri ca Po la nd Ind on es ia Tur ke y C olo m bia Ph ilip pin es (US$bn)

250 _{China, Brazil and Taiwan contributes 58%} to total dividends paid by EM markets

0 10 20 30 40 50 60 70 80 A us t Th ai S af S ing UK Tai w an Eu rop e M al ay _HK Lat am EM W or ld A si ax J D M C hi na Ind o U SA _Phil Jap an K ore a Ind ia

% of stocks with dividend yield >3% Australia offers the most

stocks with yield more than 3% followed by Thailand Some 39% of MSCI EM stocks have a potential dividend yield of over 3% China and Brazil are the largest paymasters in dollar terms

(21)

Dividend growth - Emerging markets lead the way

Emerging markets are also attractive from a dividend-growth perspective. Figure 23 shows the dividend growth through a DPS index rebased to 100 as of FY00 for different regions. MSCI EM and Asia ex-Japan companies witnessed the best DPS growth during the past decade while dividend growth has been slowest in the USA. We believe that the difference in emerging- and developed-market growth rates will persist, making a compelling case for the former. Japan’s dividend growth was in line with the other developed markets until 2007, but since then dividend growth has been similar to that of emerging markets. Perhaps this explains why a number of Japan stocks are also offering substantial dividend yields.

Figure 23

MSCI regions and markets - Dividend index since 2000

Source: Factset, CLSA Asia-Pacific Markets

Further breakdown of DPS growth by markets suggests that Russia and China have witnessed the highest growth during the past decade. On the other hand, Hong Kong and Germany have had the slowest growth in dividends. Among developed markets, Singapore stands out with a DPS Cagr that exceeds the MSCI EM stocks, and is followed closely by Australia.

Figure 24

MSCI regions and markets - Dividend Cagr since 2000

Source: Factset, CLSA Asia-Pacific Markets 50 100 150 200 250 300 350 400 450 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 AxJ Europe EM DM USA Japan DPS index rebased to 100

EM have seen highest growth among regions followed by Asia ex-JP and Japan

0 5 10 15 20 25 30 35 R us si a C hi na S ing ap or e B ra zi l S out h A fr ic a EM A us tr al ia A xJ Ind ia K ore a Tai w an Jap an W or ld _DM Eu rop e Fr an ce U SA UK G er m an y HK DPS Cagr since 2000 (%)

Russia and China witnessed highest growth among all bigger markets

Dividend growth has been highest for EM

US has slowest dividend growth, masked

by buybacks

Dividends in Russia and China grew the fastest

Germany and Hong Kong lag in dividend growth Japan’s dividend has also grown at a good pace

(22)

Yield and growth

A common misconception is that high dividends (or high-yield strategies) preclude growth. It seems logical if one assumes that dividends are a signal that a company does not have enough growth opportunities anymore and is looking to return cash to investors instead of investing. Academic research (Surprise! Higher Dividends = Higher Earnings Growth, Arnott and Asness, Financial Analyst Journal January-February 2003) has shown such conventional wisdom to be wrong for the USA, finding that over the long term, high payout ratios have actually been precursors to periods of high growth. We continue to believe that if investors want a cross-cycle strategy they need to focus on opportunities that provide both yield and growth. In Figure 25 we show that a number of emerging markets offer both higher-than-average yield and higher-than-market growth. However, some of the highest-yielding developed markets such as Australia and Europe offer lower growth.

Figure 25

MSCI regions and markets - Yield versus growth

In Figure 26 we present a similar analysis for the Asian sectors. It highlights that tech hardware and consumer discretionary sectors offer both yield and growth.

Figure 26

MSCI Asia ex-Japan sectors - Yield versus growth

World EM DM APxJ AsiaxJ USA Europe Latin America Australia Brazil Canada China France HK India Indonesia Italy Malaysia Mexico Peru Philippines South Africa Thailand UK 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 EPS Cagr (13-14F, %) 12MF dividend yield (%) Colombia (2.6, 3.0) Germany (3.2, 3.5) Singapore (4.9, 3.5) Japan (26.4, 2.2) Korea (15.1, 1.2) Chile (21.1, 2.8) Taiwan (19.0, 3.3) Autos Banks Cap gds Cons dur Cons svcs Div fin Energy

Food & drug

FBT Healthcare HPC Insurance Materials Media Pharma

Real estate _Retail

Semis Software Tech HW Utilities 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5 9 13 17 21 EPS Cagr (13-14F, %)25 29 12MF dividend yield (%) Transport (40.4, 2.6, 2) Telecom

Higher yield does not always mean lower growth

South Africa, Brazil and Thailand offer higher growth and yield

USA returns most of the cash through buybacks, so the effective yield is closer to 4%

Consumer discretionary and tech hardware has higher growth and yield Asian sectors have yield and growth

CLSA Microstrategy Dividend 2013-3-01

Desh Peramunetilleke

Mahesh Kedia

Shrikant Kale

Global

Microstrategy

Dividend wave 2013

A global theme for all seasons

Contents

Dividend wave 2013

Dividends illustrated

Global overview

Dividend wave

Investment highlights

Summary of case studies and screens

Global dividend overview