STOCKS FOR ALL SEASONS
Amy Feldman. Money. New York: May 2004.Vol.33, Iss. 5; pg. 64, 3 pgs
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Abstract (Document Summary)
Dividend-paying stocks offer a steady stream of income while the market treads water,
yet you don't have to give up on the possibility of growth once equities rebound. The
appeal of dividends includes stability, lower volatility, protection against inflation, and
bond-like income streams. The mere fact that a stock pays a dividend, of course, doesn't
make it a buy. There are several factors to consider when evaluating yield stocks,
including the company's dividend history and its ability to maintain or raise its payout in
the future. Strategies for finding outstanding dividend stocks are detailed and 9 attractive
choices are profiled. Some strategies are: 1. Look for financial strength. 2. Think of total
return. 3. Take a chance on a turn-around. Nine outstanding dividend stocks are: 1.
Altria, 2. Bristol-Myers Squibb, 3. ChevronTexaco, 4. Citigroup, 5. Duke Energy, 6.
ExxonMobil, 7. Kimberly-Clark, 8. U.S. Bancorp, and 9. Washington Mutual.
Full Text (1660 words)
Copyright Time Incorporated May 2004[Headnote]
STEADY PAYERS ARE THE BEST DEALS IN TODAY'S MARKET
Where do you put cash at a time like this? Bond yields are at record lows, moneymarket
accounts pay next to nothing, and the stock market looks highly uncertain. One answer:
dividend-paying stocks. The dividends offer a steady stream of income while the market
treads water, yet you don't have to give up on the possibility of growth once equities
rebound. * Better yet, because income investing has been out of style for so long, you
can find compelling values among dividend-paying stocks. Over the past 12 months
(through March 24), the dividend stocks in the S&P 500 have risen 36%, while their nondividend-paying counterparts have soared 57%, according to Thomson/Baseline. Partly
as a result, dividend-paying stocks in the S&P 500 trade at less than half the average
price/earnings ratio of their nonpaying counterparts. The gap "is staggering," says Larry
Keblusek, chief investment officer of Mellon's private wealth management group.
Over the past few weeks, the market, recognizing the value in yield stocks, has been
shifting from the low-quality, speculative names that dominated last year. While it's too
early to know if this rotation is for real, it may mean that dividend stocks will finally have
their day. Certainly, smart investors can gain by looking at them now.
What's the appeal of dividends? Stability, lower volatility, protection against inflation and
bondlike income streams. Last year's tax cut offered an added bonus for income-seeking
investors by slashing the tax investors owe on qualified dividends to 15% from marginal
income tax rates that had been as high as 38.6%-putting an extra $14 billion in investors'
pockets. (Dividends on most common stocks qualify for the tax break; dividends on most
real estate investment trusts and preferred stocks do not.)
Companies have begun to respond to the tax break. Since the beginning of 2003, 23
companies in the S&P 500 have started offering dividends for the first time, bringing the
total number of dividend payers in the index to 372. And 223 companies in the index
have tipped their dividends once or more-for a total of 332 increases. More are expected
to follow. Goldman Sachs accounting analyst Michael Clement and strategist Abby
Joseph Cohen argue in a recent report that this will be "a year of notable dividend
activity, with much of it concentrated in the first half of the year."
The mere fact that a stock pays a dividend, of course, doesn't make it a buy. There are
several factors to consider when evaluating yield stocks, including the company's
dividend history and its ability to maintain or raise its payout in the future. Below, we'll
detail strategies for finding outstanding dividend stocks and profile nine attractive
choices.
1 Look for financial strength Yield itself tells you very little about the quality of a
company. Remember, when a company decides to pay a dividend, it sets a fixed amount
per share; the yield is the total annual dividend divided by the stock price. So when the
stock price sinks, the yield rises. That means you have to proceed with care. "Usually
when people think of dividends, they think in terms of yield," says Don Taylor, manager
of Franklin Rising Dividends fund. "But a lot of times when you screen for yield, you
screen for problems." Of course, the market may be overreacting to those problems,
creating a buying opportunity in a solid stock that is in a temporary slump.
For his part, Taylor prefers a conservative approach: He searches for companies that
have increased their dividends in at least eight of the past 10 years and have the
financial strength to continue to do so in the future. To gauge a company's financial
strength, look to two key numbers: the debt-to-capital ratio (a figure of 50% or less is
good) and the payout ratio-that is, the percentage of earnings that the firm pays out in
dividends. Dividend payout levels vary widely by industry, but here again look for a ratio
of 50% or less. (For comparison, among dividend-paying stocks in the S&P 500, the
average payout ratio is 37% and the average debt-to-capital ratio is 40%.) But these are
just rough guidelines, and there are many exceptions. For example, banks tend to have
higher debt-to-capital ratios. And if you're playing a turnaround or an industry coming out
of a cyclical downturn, the payout ratio is likely to be well above 50%.
Another gauge of financial strength is a long history of paying-and even better,
increasing-dividends. Standard & Poor's quantitative services division tracks a list of
what it calls "dividend aristocrats," companies that have raised their dividends for 25
consecutive years.
One of the highest-yielding names on that S&P list is Altria Group, the old Philip Morris,
which now yields 5.1%. Altria is a favorite of value investors such as David Dreman and
Vanguard Windsor II's Jim Barrow. The world's largest tobacco company is a modest
grower that throws off a lot of cash and, at a price of 11 times forecast 2004 earnings,
"it's a good place to get excess returns as long as you don't trip on the litigation land
mine," says Jonathan Golub, equity strategist at J.P. Morgan Fleming Asset
Management.
The consumer-staples sector offers plenty of other consistent dividend plays, Golub
says. "These companies have a steady stream of earnings and a very stable way of
generating dividends," he says. Consider Kimberly-Clark, the diaper and paper goods
giant, which most recently raised its dividend in January and now yields 2.7%. It's got a
strong balance sheet (with debt to capital at 29% and a payout ratio of 40%) as well as
sizable market share with products like Huggies and Kleenex. The stock trades at 17
times this year's estimated earnings, while far larger Procter & Gamble sports a 23 P/E.
2 Think total return In boom times, when the market is notching double-digit gains every
year, dividends can seem trivial. But over time they make an important contribution to
your gains. Since 1926, dividends have accounted for more than 40% of stocks' total
return. A company that offers modest earnings growth and a reliable dividend may be a
better bet than a high flier posting profit increases that it probably can't sustain. Two
sectors where you can find slow and steady stocks: energy and financial services.
In energy, for example, Goldman Sachs figures that both ChevronTexaco, which yields
3.4%, and ExxonMobil, which yields 2.5%, will be among those to increase their
dividends significantly this year. After all, the sector has the wind at its back from rising
oil and gas prices, and both companies have rock-solid balance sheets. ExxonMobil is
the industry leader, but ChevronTexaco stock trades at a discount-13 times forecast
2004 earnings vs. 16 times for ExxonMobil. As Tom Sassi, lead manager of Scudder
Large Cap Value fund, which owns ExxonMobil, ChevronTexaco and a slew of other
dividend payers, puts it, "Yield is important, but more important is that dividends are
growing over time."
In financials, meanwhile, we've regularly recommended Citigroup and Washington
Mutual. Both sport yields above 3%, modest payout ratios and belowmarket valuations.
Citigroup has an unparalleled array of global financial businesses, while Washington
Mutual, which does big business in mortgages and commercial real estate loans, has
been a big gainer from the housing boom.
Looking beyond those familiar names, there is a less popular bank worth considering.
U.S. Bancorp, the nation's eighth-largest bank, has steered clear of the megaacquisitions now sweeping the banking industry. But it generates a return on capital of
7.6%, well above average and in line with Citigroup's; its return on equity, at 19.7%, puts
it near the top of the pack as well. "It is still cheap relative to competitors," says Anna
Dopkin, manager of T. Rowe Price Growth & Income fund, which counts U.S. Bancorp
among its largest positions. Dopkin figures the stock will be higher next year-plus
investors get a 3.5% dividend while they wait.
3 Take a chance on a turnaround As we mentioned above, a high yield can be a sign of
trouble, but it can also point to worthy stocks that are temporarily out of favor. If you're
looking for a turnaround play, consider Bristol-Myers Squibb, a beaten-down company
that has recently attracted a lot of attention from value investors. The stock has suffered
from a spate of problems: litigation, accounting restatements and competition from
generics. Bristol's biggest seller, Pravachol (a cardiovascular drug), for example, is
scheduled to come off patent in 2006. But it's a nice value: The stock is 67% off its high
of the past five years and now trades at just 16 times this year's expected earnings, far
below the average for big pharmaceutical companies. The dividend yield, at 4.7%, is the
highest among the drugmakers, which gives investors a cushion while they wait for the
real payoff: new drugs in die pipeline. "The thing that is most under-appreciated about
Bristol is the quality of its mid-stage pipeline," says Judson Brooks, an analyst at the
Oakmark Funds, which has been accumulating shares. "At $25, you're not paying more
than a dollar or two for everything that is not disclosed yet, so that creates what we think
is a margin of safety."
Our final turnaround prospect comes, oddly enough, from the utility industry, once loved
by dividend investors for its stability. Duke Energy is not your grandma's utility play; in
fact, it's outside our conservative parameters for both debt-to-capital and payout ratios.
But a new management team, led by turnaround specialist Paul Anderson, is making
strides in paying down debt, cutting costs and selling underperforming assets. And the
stock currently yields 5%. "It's in the middle of a financial turnaround," says T. Rowe's
Dopkin, who often buys when sentiment is at its worst. "We think fears of a dividend cut
are unfounded, and the valuation is attractive."
[Sidebar]
DURING BOOM TIMES DIVIDENDS MAY SEEM LIKE SMALL CHANGE. BUT OVER
TIME THEY CAN REALLY BOOST YOUR RETURNS