TARP And Dividend Growth

There are a large number of parameters that are a part of the Treasury's TARP (Troubled Asset Relief Program). One of the aspect of the plan financial investors will want to watch is the dividend increase stipulation. One of the TARP parameters requires institutions that accept TARP funds to obtain the Treasury's approval before any increase in a company's common stock dividend until the third anniversary of the date the treasury invests in the firm. Additionally, the treasury's approval is required before any share repurchases.

A few other TARP parameters:

• The senior preferred shares will pay a cumulative dividend of 5% annually for the first 5 years and will reset to 9% per year after year 5. These shares will be non-voting.

• The senior preferred shares are callable at par after 3 years.

• Prior to the end of 3 years, the shares may be redeemed with the proceeds from a qualifying equity off erring of any tier 1 perpetual preferred or common stock.

• The Treasury will receive warrants to purchase common stock at an aggregate market price equal to 15% of the senior preferred investment. The exercise price on the warrants will be the market price of the participating institutions common stock at the time of issuance (calculated on a 20-trading day trailing average).

Source:

Treasury Announces TARP Capital Purchase Program Description
U.S. Department of the Treasury
October 14, 2008
http://www.treas.gov/press/releases/hp1207.htm

Vectren Increases Dividend 3%

Today Vectren (VCC) announced a 3.08% increase in the company's quarterly dividend. VVC is one of Standard & Poor's S&P 1500 companies that has increased its dividend each year for at least the last ten years. In fact, this is the 49th consecutive year Vectren has increased its dividend.

The new quarterly dividend increases to 33.5 cents per share versus 32.5 cents per share in the same quarter last year. The company's 5-year average dividend payout ratio is approximately 67%. The projected payout ratio on the new dividend is approximately 64% based on 2009 estimated earnings per share of $2.09. The company's S&P Earnings & Dividend Ranking is B+.

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Suntrust Reduces Dividend

Yesterday, Suntrust (STI) cut its quarterly dividend 29.9%. The new quarterly rate will equal 54 cents per share versus 77 cents per share in the same quarter last year. At the time of the announcement, the company stated it has received preliminary approval from the U.S. Treasury for the sale of $3.5 billion in preferred stock and related warrants to the U.S. Treasury under the Capital Purchase Program of the Emergency Economic Stabilization Act of 2008.

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Income Tax Uncertainty Weighing On Market

Many factors are weighing on the stock market. One of the factors likely impacting the markets is the potential drag Barack Obama's tax plan would have on businesses and U.S. investors.

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• Mr. Obama would roll back the 2001 and 2003 tax cuts for taxpayers in the top two brackets, raising the top two marginal rates of income tax to 36% and 39.6% from 33% and 35%. The 33% rate begins to hit this year at incomes of $164,550 for an individual and $200,300 for joint filers.

• If you're an individual with taxable income of $164,550, you will pay more taxes.

Particularly of concern is Mr. Obama's desire to eliminate the cap on payroll taxes. This has negative consequences for small business and it is small business that create most new jobs in the U.S.

• Mr. Obama's most dramatic departure from current tax policy is his promise to lift the cap on income on which the Social Security payroll tax is applied.... it's unclear if that higher rate would apply to the employee, the employer, or both.

If Mr. Obama's plan is instituted as proposed, a further slowing of the U.S. economy is likely. A slowing U.S. will have implications for global markets as well.

Updated: 9:50AM:

And this additional concern with respect to wealth redistribution.

Source:

The Election Choice: Taxes
The Wall Street Journal
By: Brian M. Carney
October 25, 2008
http://online.wsj.com/article/SB122488938501868507.html?mod=todays_us_opinion

What Is The VIX Index

(I originally posted an article on the VIX Index on The DIV-Net website on October 19, 2008)

One market indicator that has been getting a lot of attention lately is the VIX Index (VIX). The VIX has been in the news lately since the Index has been hitting all time high levels, reaching over 89 on Friday (10/24/2008). The importance of the VIX has to do with the fact it is a measure of investor fear looking forward over the subsequent 30 day period.

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According to the CBOE,

since the VIX Index introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility. The VIX Index is an implied volatility index that measures the market’s expectation of 30-day S&P 500® volatility implicit in the prices of near-term S&P 500 options. VIX is quoted in percentage points, just like the standard deviation of a rate of return.

Additionally, one of the most interesting features of VIX, and the reason it has been called the “investor fear gauge,” is that, historically, VIX hits its highest levels during times of financial turmoil and investor fear. As markets recover and investor fear subsides, VIX levels tend to drop. This effect can be seen in the below chart in the VIX behavior isolated during the Long Term Capital Management and Russian Debt Crises in 1998.

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An important historical aspect of the VIX is it tends to reach high levels at market bottoms. Could the current high level be signaling a market turning point looking forward. Last week's 4.7% market advance is certainly a start.

Source:

VIX (pdf)
CBOE Volatility Index White Paper
http://www.cboe.com/micro/vix/vixwhite.pdf

Aflac Announces 16% Increase In Dividend

Earlier this week Aflac (AFL) announced a 16.67% increase in the company's first quarter 2009 dividend. The new quarterly dividend will equal 28 cents per share versus 24 cents per share in the first quarter 2008. The estimated payout ratio on the new dividend is approximately 25%. This compares to the five year average payout ratio of 19%. The company carries a S&P Earnings and Dividend Quality Ranking of A.

The company's third quarter earnings indicated net income fell to $100 million, or 21 cents a share, from $420 million, or 85 cents a share, in the third quarter of 2007. About $198 million of the after-tax investment losses in the quarter partly stems from the company's decision to sell its holdings in Lehman Brothers and Washington Mutual and impair its investment in Ford Motor. Operating earnings, which exclude net realized investment gains and losses, were $493 million, or $1.02 a share.

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Some Positives Developing That May Signal A Market Bottom Is Near

A couple of recent posts highlighted below, indicate a market bottom could be forming.

• Political Calculations has an interesting analysis on the implications of declining trailing dividends in the post, A Silver Lining In The Stock Market.

• The Big Picture website contains a post, S & P 500 forming "W" Bottom?, using technical analysis that suggests the S&P 500 Index may be forming a bottom. Additionally, Barry Ritholtz notes:

• This suggests accumulation and could suggest a complex bottoming formation is occurring, particularly when one looks at the recent extremes in sentiment data.

Bullish And Bearish Sentiment Gridlocked

Given the wide daily swings in the market, I am not surprised this week's sentiment survey by the American Association of Individual Investors shows an equal percentage of bullish and bearish investors: 38.74%. From a contrarian perspective, the sentiment indicator marks a market bottom when individual investors are the least bullish. The low 20% area or in ta reading in the teen range would be such an area.

Given the market weakness experienced since October of last year and a bullishness reading that has ranged in the 30-40% area, investors do not seem overly bearish. One would think the market would be acting better based solely on these investor sentiment readings. That raises the question-who is doing all the selling. When this period is evaluated at some point in the future, I would not be too surprised if much of the selling has been hedge fund and institutionally driven.

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Source: American Association of Individual Investors

S&P Decreases Expected 2008 Dividend For The S&P 500 Index

Today, Standard & Poor's is lowering the S&P 500 Index 2008 estimated dividend by 2.8% to $28.05 versus the prior estimate of $28.85. Although S&P is lowering the expected dividend, it remains above the dividend level recorded in 2007, i.e., $27.73. The indicated dividend rate for the S&P 500 Index has also been lowered to $27.35. S&P's Senior Index Analyst, Howard Silverblatt attributes the reduction to potentially negative government actions that might limit the dividend with additional cuts anticipated in 2009.

Most of the dividend cuts have been centered in the financial sector--35 in total; however, Howard Silverblatt notes S&P:

"...believes that the majority of S&P 500 companies will continue their long history of dividend payments and increases, with over half of them expected to pay out more this year than last."

Source:

S&P Decreases Expected 2008 Dividend Payment for the S&P 500 Index
Q4 Payments Expected to Decline 10% - Worst Since 1958 (PDF)
Standard & Poor's
By: Howard Silverblatt & David Guarino
October 21, 2008
http://www2.standardandpoors.com/spf/pdf/index/102108_DividendRateChange-PR.pdf

Better Investing's Most Active Stocks

Better Investing is a community of individual investment clubs throughout the U.S. The organization has been in existence for 57 years and gives individual investors an opportunity to:

combine Better Investing's proven investing approach with the knowledge, tools and community support their members need to become smarter, more successful investors.

Below is a listing of the most active stocks from Better Investing members taken from an informal sampling of 147 transactions as of October 19, 2008.

Source: Better Investing

Another Management Evaluation Tool

(I originally posted a portion of this article on The DIV-Net website on October 12, 2008)

As a follow up to one of my post last week on evaluating management using ROE, this post will touch on an additional management evaluation tool. Before I do that though, these are extraordinary investment times and many an investor are unsure of what to do next. Many factors will go into that ultimate decision, but I believe Warren Buffett said it best a few weeks ago:

"You know, five years from now, ten years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well."

A key aspect to the success of a company and its stock price is the strength of the company's management. In fact, if this one element is missing, no matter how good a company or its competitive advantage, the lack of strong management can lead to poor company results.

In addition to evaluating the company's ROE, investors should review the company's shareholder letter that accompanies the firm's annual report. The American Association of Individual Investors recently wrote an article on elements to look for in the letter. The article notes:

The one window into a CEO's perspective and goals is the shareholder letter contained in the annual report. But upon reading one, you might find that you can't understand what the CEO is trying to say. Often, shareholder letters are riddled with jargon and glossy prose that convey no information. Six of the most popular CEO letter clichés:

• Talented people,
• Global presence,
• Market knowledge,
• Financial strength,
• Leverage competitive advantages, and
• Create significant value for our shareholders.

The article indicates investors should read the shareholder letter and circle in red the cliché phrases outlined above. If one sees more red than black, be forewarned. Once the company passes this test, there are seven criteria an investor should score. The AAII article contains more detail on each criteria, but a summary is listed below:

• CEO Voice—Personal and Authentic: When you finish reading the shareholder letter, do you feel like you had a meeting with the CEO? Do you feel as if the CEO is talking to you?... A CEO's attitude toward shareholders can reveal how he or she runs the business—for long-term profits or short-term gain. You need to read between the lines of the letter to try to figure out what kind of "relationship" a CEO is looking for

• Practicing the Financial Golden Rule: Is the CEO giving you information that he would expect to receive if he were the investor?

• Detailed and Jargon-Free Information: Is the CEO explaining complex topics in simple terms without "dumbing" down this information? Is the letter free of clichés and technical jargon?...

The best letters provide business details in simple, but never simple-minded, language. And they explain how these investment opportunities will produce profits.

• Consistent and Realistic Information: Has the CEO provided historically consistent information, especially with regard to the company's earnings? Is the CEO explaining the company's goals and how the company intends to meet its goals?...

A CEO who wants to show that he or she is trying to be accountable to investors and other stakeholders is going to tell you about their corporate goals. Financial goals reveal the financial targets that CEOs want their companies to achieve; operating goals reveal the CEO's aspirations to improve the way the work gets done.

• A Proper Accounting of Earnings: Does the CEO letter reveal an understanding of the difference between the company's cash and accounting earnings? Can you find statements of earnings in the shareholder letter and easily locate this same number on the firm's income statement in the annual report?

Even when CEOs do report company earnings, it's often hard to figure out what they mean. You can blame part of this problem on accounting.

Earnings can be reported at different "layers." Many CEOs choose to report their earnings in shareholder letters several layers up, typically at a level that lets them show their company's earnings in the best possible light. This is not illegal. But when companies offer these customized pro forma earnings, you'll want to examine the underlying assumptions the company is using to calculate them.

To judge management's accounting integrity in the shareholder letter, look for:

• Clarity in reporting the nature of non-routine write-offs that affect company earnings; and
• Consistency in the presentation of earnings over time.
  

• Balanced Strategic Sense: Does the CEO include a balanced picture of the execution of the company's strategy and its results? Are you learning about the year's business failures as well as the successes?...

The topic that is most frequently cited in a shareholder letter is "corporate strategy." This should be no surprise—when we learn about a company's plans to make money from tangible assets, like plants and equipment, and intangible assets, such as patents, brand recognition and new technology—we get to the heart and soul of financial analysis.

Many companies describe the corporate strategy as a list of action steps they intend to take. But such a list only tells you what a CEO plans to do. They don't show how these steps are being acted out in real-life situations....

• CEO Values:Is the CEO describing his or her values and are these related to specific events in the company? Do you gain more understanding about how the CEO and his or her company practice these values in relation to their corporate stakeholders: employees, customers, investors, suppliers and others?

A key investor takeaway from reading the letter is whether or not you feel comfortable entrusting your investment dollars to a company's particular management. So when you receive an annual report, read the shareholder letter first.

Source:

Shareholder Letter Revelations: Can You Trust the Leadership?
American Association of Individual Investors
AAII Journal
2008
http://www.aaii.com/includes/DisplayArticle.cfm?Article_Id=2310&digit=524

Important To Look At Small Business Trends

One segment of economic information that I find important to review on a regular basis is data on the small business segment of the economy. Small business represents roughly 99.7% of all employer firms and 80% of all new jobs in the U.S so the health of this segment is important to future economic growth. The NFIB organization, National Federation of Independent Business, is the leading small business association representing small and independent businesses. It is a nonprofit, nonpartisan organization founded in 1943.

The NFIB Index of Small Business Optimism rose 1.8 points to 92.9 in September continuing one of the longest strings of recession level readings in the history of the survey (started in 1973), but headed up for the second month in a row.

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In addition to this small positive, small business owners continued to liquidate inventories, a negative for third quarter Gross Domestic Product numbers. However, when, not if, the economy starts to gain traction, these low inventory levels will mean small companies will need to ramp up production quickly. This will contribute to a rapid restart to economic growth.

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The U.S. Census Bureau's inventory to sales ratio also remains in a longer term downtrend.

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Chart Courtesy of U.S. Census Bureau

Source:

NFIB Small Business Economic Trends (PDF)
National Federation of Independent Business
By: William C. Dunkelberg and Holly Wade
October 2008
http://www.nfib.com/object/IO_38976.html

Dow Jones Industrial Average Up For The Week

It certainly did not feel like the Dow Jones Industrial Average ($INDU) was up 401 points (4.75%) for the week given the high level of volatility. As the weekly Dow chart below details, this was the first week in the last five that the Index ended in positive territory.

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The VIX Index ($VIX) reached a surprisingly high level over 81 on Thursday and continues to trade at elevated heights.

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A few prominent investors are using this opportunity to build equity positions. The following two articles contain some talking points from Warren Buffett.

• Buy American. I am. (NY Times)

• America For Sale: Price Reduced (Barron's)
  

Investor Bullish Sentiment Rises And Redemption Overhang

Individual investor bullish sentiment rose to 40.94% versus last week's reading of 31.47%. Equally impressive was the decline in bearish sentiment to 39.77% versus the prior week level of 60.84%. The bull/bear spread narrowed to -20% versus last week's spread of -29%.

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Data Source: American Association of Individual Investors

Is it likely a large part of the market down draft is being driven by hedge fund redemptions? Dow Jones News Wire reports in an article today, Each Market Rally To Be Met By Wave Of Redemption Selling,

In its weekly flow report, TrimTabs Investment Research estimated hedge funds had a record $43 billion outflow in September alone, with flows into hedge funds down 56% for the first eight months of the year. In addition, redemptions for mutual funds this year have totaled about 12% of the total assets in each fund, well above the 8% TrimTabs had expected.

A report from JPMorgan estimated about $100 billion in redemption requests for funds of hedge funds in the fourth quarter, noting that $400 billion in overall position unwinding was likely over the coming year. In prior years, redemptions were well below fund inflows, but the tables started to turn late in 2007. In its most recent second-quarter report, HedgeFund.net said there was a total fund outflow of about $470 million for that quarter, while a Merrill Lynch survey found fund managers are holding more cash than they have in years.

This movement of money is essentially stamping out any significant stock market rally. Some traders saw rallies late last Friday, Monday and early Thursday as signs of a recovery in equities, but fund managers viewed them another way: Get out while you can. They're taking advantage of the modest gains to sell shares and thus satisfy investor redemptions. This has fueled big falls, including Wednesday's 733-point drop in the Dow Jones Industrial Average - the biggest one-day percentage drop since October 1987.

A flood of investor redemptions before Oct. 1 deadlines forced several funds to liquidate positions quickly, causing the wave of selling last week. Funds typically have until the end of the year to pay, but many were inundated with more requests than expected, so quickly sold to raise a cash buffer.

When the selling pressure from hedge funds subsides, the cash sitting on the sidelines could find its way into the equity markets pretty quickly.

Source:

Each Market Rally To Be Met By Wave Of Redemption Selling
Dow Jones Newswire via INO.com
By: Geoffrey Rogow and Joseph Checkler
October 16, 2008
http://news.ino.com/headlines/?newsid=20081016013926

Living Within Your Means

Consumer credit outstanding declined by 3.7% in the month of August. An obvious sign that the credit crunch has spilled over into the consumer segment of the economy. Argus Research notes, "The decline was the result of a 0.8% drop in revolving, or credit card, debt and a 5.4% plunge in nonrevolving debt. Miserable auto sales are the explanation for the decline in nonrevolving activity."

Source: Argus Research ($)

The big question is what impact will this have on the economy going forward.

Market Timing Dangers

Today's sharp move higher in the stock market sheds light on the dangers of an investor trying to time the market. I wrote a post earlier this year, Focus on the the Long-Term, in which it was noted missing just a handful of the market's best days in a given year can really penalize returns. If an investor missed just 40 of the biggest up days in the market over the last 20 years (1987-2007), their return would have totaled 3.98% versus remaining fully invested and achieving an average annualized return of 11.82%.

The market research firm DALBAR went one step further and looked at the returns of mutual fund investors over the 20-year period, 1986-2006, and reported the average market timer return was -2%. During this same time period, the S&P 500 Index returned 12%.

• Additionally, during the 10-year period 1997-2006, the S&P 500 Index achieved an annualized return of 8.4%. If an investor missed just the top 20 days during this period, their return fell to -.4%.

• Further, 21 of the best 40 days came during the bear market period 2000-2002.

• Lastly, nearly three-fourths of the 40 best days came within two weeks following a worst market day.

A key investment decision for an investor should be to review their overall asset allocation. If the review, and investor risk tolerance, indicates additional equity exposure is appropriate, then maybe now is a good time to begin averaging into the market.

Source:

Market Timing Doesn't Work
Charles Schwab OnInvesting
By: Liz Ann Sonders
Fall 2007
http://oninvesting.texterity.com/oninvesting/2007fall/?pg=12

Volatility and Complacency Make Strange Bedfellows
Charles Schwab OnInvesting
By: Liz Ann Sonders
Summer 2007
http://oninvesting.texterity.com/oninvesting/2007summer/

More Federal Holidays To Support Market?

If I were a government employee or bond trader, I would be a little concerned the market saw one of its biggest one day rallies on a day they were off work due to the holiday. Could this be a sign we need less government (less government spending) and fewer bond traders to trade that mortgage debt? If so, let's extend the holiday.

The S&P 500 Index finally broke its string of eight straight down days by advancing 104.13 points or 11.58%.

(click chart for larger image)

Every S&P sector saw positive returns with the Industrial being the weakest, returning 7.28%.

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Not A Depression But Lack Of Confidence

A number of economist and financial writers continue to debate whether the current events are leading the U.S. past a recession and into a depression. In short, I believe it is a recession with the lack of confidence in our financial system leading to thoughts of a depression. Following are some highlights from article across the web that support the recession (and not depression) scenario.

• Depression Fears Overblown at Charles Schwab.
  

Table Courtesy Charles Schwab & Co.

• Barry Ritholtz at The Big Picture website lists 10 Bullish Charts, Signals, Indicators.

• David Merkel at The Aleph Blog is on the fence in his post Recession or Depression.

• Todd Sullivan's - ValuePlays list statistical data pointing to Why This Is Not The Great Depression.

• Bill Conerly, Ph.D. at the Businomics Blog contains a brief discussion on the TED spread in his article, TED Spread: How High Is Financial Risk Today?, noting "the Great Moderation, the milder business cycle climate" and if you survived any of those past recessions. You'll likely survive this one, too.

• Jeff Miller, Ph.D. notes in his post, How NOT to Think about Your Investments, at A Dash of Insight, some links to the behavioral aspects to investing. Some investor decisions tend to be "knee-jerk" reactions.

• And what does Warren Buffett say about the current environment. This from a few weeks ago:

"You know, five years from now, ten years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well."

So don't make investment decisions by looking in the rear view mirror. As noted in Warren Buffett's quote above, a week or a month from now we may see additional downside volatility. Five and ten years from now: likely higher prices.

Evaluating Management Using ROE

(I originally posted this article on The DIV-Net website on October 5, 2008)

Few factors are more critical in determining the potential success of a company than the quality of a firm's management. During economic and financial times like these, a quality management team can make the difference between success and failure. Certainly a company's dividend practice provides insight into management's anticipated view of future business prospects. Another variable that provides a clue to a company's anticipated prospects is return on equity (ROE) trends.

Return on equity provides information on how well management has invested the capital supplied by its shareholders. ROE is calculated by dividend earnings per share by book value per share than multiplying by 100 to convert to a percentage. In a recent article in BetterInvesting Magazine, it is noted adjustments may need to be made to equity to get an accurate measure of book value.

A company’s book value is determined by subtracting long- and short-term debt from the company’s total assets. It represents what a shareholder would get if the company and its assets were sold at cost. A note of caution about book values: If you’re dealing with a company that has most of its assets related to intellectual property or brands, the figure might be more art than science. The book value of drug patents, factory equipment and vehicle fleets are easily quantified. The book value of a brand isn’t so firm (though it would be foolish to say that brands such as Coca-Cola and McDonald’s don’t have value).

When companies use debt to finance growth, the debt level can inflate the ROE number due to the equity number in the denominator being smaller. Consequently, for firms that carry high debt levels, the resulting higher ROE may not be an effective gauge of management effectiveness. When evaluating the ROE, the return figure should be evaluated on a trend basis as well as compared with its peers.

In general, a higher ROE means the company is generating capital with its existing assets. This ability to generate capital internally means the company is less likely to issue more equity (dilutive) or take on more debt. The additional capital that is generated can then be used for business expansion, stock buybacks and/or dividend increases.

Additionally, I published a post on The DIV-Net website today that covers another management evaluation tool: reviewing the shareholder letter. In addition to the detail on the shareholder letter review, the post contains some advice from Warren Buffett on potential expectations for the coming weeks ahead.

Source:

Measuring Management by Return on Equity ($)
BetterInvesting
By: Michael Maiello
September 2007
http://www.betterinvesting.org/Public/default

RPM International Increases Dividend 5.3%

RPM International (RPM) announced the company will increase its quarterly dividend to 20 cents per share versus 19 cents per share in the same quarter of last year. The estimated payout ratio is approximately 44% based on estimated May 2009 earnings of $1.78.

The company notes in its press release:

This action marks RPM's 35th consecutive year of increased cash dividends paid to its stockholders, which places RPM in an elite category of less than half of one percent of all 19,000 publicly-traded U.S. companies. Only 67 other companies, besides RPM, have consecutively paid an increasing annual dividend for this period of time or longer, according to the 2009 edition of America's Finest Companies.

It should be noted though the company did go eight quaters, October 31, 2000 through July 31, 2002, without increasing the dividend. During this time period the dividend remained at 12.5 cents per share. Nonetheless, given these difficult market times, this is a welcomed dividend increase.