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High Dividend Yields Screened for Safety

Many investors have been shifting out of bonds into income-oriented equities. I have favored this strategy, but it's very important to realize that dividends aren't the same as interest payments: They can be cut. In that case, not only will your income be less than you expect, but also your investment will most likely decline in value.

If you are employing an equity substitution strategy, it's essential to take steps to mitigate the risk of dividend reductions and consequent capital losses. Some of the factors that make a dividend-paying stock risky would include high levels of debt, high payout ratio (dividend relative to earnings), and a shrinking business (lower future earnings). You can minimize the risk of getting a dividend cut by investing in low-debt securities with lower payout ratios and underlying earnings growth. Another indicator of limited potential for dividend reduction is high insider ownership.

I set up a screen to identify stocks that meet the criteria. Here is what I did (using Baseline):

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Small-Caps, Big Dividends, High Insider Ownership

There is a lot of focus these days on stocks with high dividends, and rightly so considering the alternatives. Many investors seeking high-yielding stocks limit themselves to larger, well-known companies in the belief that they are somehow "safer" than smaller companies. It would seem that the experiences of 2008 and 2009 would negate that preference - anyone remember the high yields of the banks and companies like GE? There are many metrics we can use to minimize the risk of getting our dividends slashed, including strong balance sheets and low payout ratios. Another one that I like to see is high inside ownership, as "principals" are less likely to cut the dividend (and to pull cash out of their own wallets) than "agents". With that in mind, I ran a screen of smaller companies with positive attributes.

 

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Joplin Tornado Blows Away This Company's Dividend

 

Empire District Electric Company (EDE) is yet another victim of the horrific devastation from the tornado in Joplin this past weekend. The stock had initially declined modestly earlier this week, but it plunged yesterday by 15%, wiping out $125mm in market value after the company suspended its dividend for two quarters. The company cited 8-10k customers that will be out of service for the forseeable future that will result in 10-15% loss of revenue and damage repair of $20-$30mm before potential insurance recoveries.

 

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Sharing My Conservative Growth/Balanced Ideas for 2011

When I launched my second model, the Conservative Growth/Balanced Model Portfolio, in July of 2008, I shared the names and the philosophy behind it in a series of articles.  You can visit the last one and backtrack to the rest.  I shared an update in May 2009 and my most recent one about six months ago.  Today, I want to share all of the current holdings, like I did for my Top 20 Model Portfolio a few days ago, as well as some overall portfolio structure.

2010 was a good year for the model, with the total return of the model beating its benchmark (60% stocks and 40% bonds) by over 15%, with a return of almost 27%.  Our models were underweight bonds in the back half of the year and overweight stocks.  As a reminder, the model is subject to several rules:  Stocks vary between 45% and 75%, bonds (we use ETFs only) vary between 10% and 50% and cash can be 0% to 45%.  We carried a lot of cash during the year - that wasn't fun!

Before I share the current names and structure, I want to say that we have a pretty tough task with this model.  On the one hand, we want to grow our principal and produce income above the S&P 500.  On the other hand, though, I am charged with protecting from capital loss.  It's the old adage: Make me money but don't take any risk!

Ok, here is what the model looks like currently.  We recently took our equity exposure down from 75% to about 67% as the year neared an end.  Many of our names were extended (protect the principal at play!).  Our bond exposure, currently 19%, has increased from its minimum recently.  We have most of our exposure in the ETF iShares Barclays Aggregate (AGG), but we have some in the iShares Barclays MBS Fund (MBB), which is the mortgage portion of the index.  So, we remain quite underweight.  The balance of the model is in cash (14%).  I hope to redeploy that into stocks in the coming weeks and quite possibly into additional bonds (but no more than 25%) should the opportunity arise.

Here are our current stock holdings:

• Applied Materials (AMAT)
• C.R. Bard (BCR)
• Franklin Resources (BEN)
• Cal-Maine (CALM)
• Chico's (CHS)
• Cisco (CSCO)
• Chevron (CVX)
• Flowers Foods (FLO)
• Johnson & Johnson (JNJ)
• Lowes (LOW)
• Met-Pro (MPR)
• National Bankshares (NKSH)
• Owens & Minor (OMI)
• Portland General (POR)
• Walgreen's (WAG)
• Xilinx (XLNX)

Not all of the positions are the same size - you can find out our weightings by signing up for a free trial.  Unlike my Top 20 Model Portfolio, which is 31% Industrials and 29% Technology, we take a more balanced approach in CG/B.  The 67% in stocks is allocated 23% Technology, 21% Healthcare, 19% Consumer Staples, 13% Financials, 10% Consumer Discretionary and 5% each to Industrials, Utilities and Energy.  That's 8 out of the 10 sectors (no Materials or Telecom Services, both of which are very small parts of the S&P 500).

In terms of market caps, we have some Small-Cap exposure, but it's not as extreme as Top 20. Our median is over $8 billion, with an average of over $42 billion. We do have 2 names that are below $200mm and another below $1 billion. The median PE ratio is about 14X, with the portfolio-weighted PE at 13.7X. Our dividend yield is about 2.2%, which is above the market. Our balance sheets are very strong, with the median company having just slightly more debt than cash. Even our portfolio-weighted net debt to capital is just 8% compared to about 30% for the S&P 500. 1/2 the names have more cash and short-term investments than debt, and, if one includes long-term investments, then the vast majority are net cash positive. Like Top 20, our stocks aren't run-up as much as the market. On a portfolio-weighted basis, our stocks that we currently hold advanced 2.4% in 2010.

I hope that the very conservative nature of this portfolio is evident from the characteristics I described. We have good economic sector diversification, exposure to a very broad range of market capitalizations, strong balance sheets and moderate average underperformance over the past year. A few of the names are currently overbought (5 moderately and 1 significantly) - hence the recent throttling back of our exposure. My goals in this portfolio are to beat the combined index by 8-12% a year. It's less than my goals for Top 20 due to the fact that we don't really add any value in our bond selection (we index) and that our opportunity set is smaller (stocks have to be "conservative"). As a reminder, we should expect to fare best relatively in down markets, to do ok in flat markets and to lag in strong markets. Thus, I was very pleased with 2010's performance. We had good stock selection, but it was our avoidance of bonds and commitment to stocks above a neutral exposure that contributed as well.

Disclosure:  Long CSCO and CHS

Bond Bulls Left Holding the Bag

I have spent the last several months discussing all sorts of equity alternatives to bonds, so this doesn't bother me:

 

As you can see, stocks (S&P 500) started in the hole, saw some sunshine, gave it up in a "flash" and now have moved to their highest YTD return yet, at 12.3% as of 12/8.  Bonds (Barclays Aggregate Bond Index) jumped up in January and kept marching ahead until recently.  Here is a chart of the cumulative differences on a monthly basis:

 
While the 6.4% advantage of owning stocks over bonds in 2010 doesn't seem especially exciting, the relative move since Labor Day has been nothing short of spectacular at +18.9%.

One of the two models I offer to subscribers at Invest By Model is the Conservative Growth/Balanced Model Portfolio.  Its charge is to produce income higher than the S&P 500 and capital appreciation over time while preserving capital in unfriendly markets.  Easy, right?  The goal is to beat a benchmark comprised of 60% S&P 500 and 40% Barclays Aggregate Bond.  I have flexibility, as I can invest in as little as 45% and as much as 75% stocks and as little as 10% or as much as 55% bonds.  We have used only ETFs to cover the bond allocation.  We can also take cash as high as 45%.

While I attribute most of our success this year to good stock selection, recently we have been aided by the sharp move in equities relative to bonds, as we have been near the 75% maximum on stocks since this summer and near the minimum 10% on bonds.   I detailed this strategy in early July:

The current portfolio is structured the most aggressively yet. We have executed a series of trades over the past few weeks that leave us at 74% stocks (near the maximum), 10.5% bonds (near the minimum) and the remaining 15.5% in cash. My rationale is that stocks are extremely inexpensive to bonds. We have 7% exposure to regulated electric utilities, which pay dividends that yield more than 2.5% above the current yield of the broad bond market, which is extreme. In fact, our overall equity portfolio has a weighted dividend of 2.8% (compared to 2.2% for the S&P 500). Of the 17 names, 12 have increased their dividends in each of the past 5 years. The dividend growth rate over the past 5 years has been 15% compared to just 1% for the S&P 500. On top of it all, the balance sheets are superb. The overall net debt to capital for the portfolio is just 11%, with 8 of the names having more cash than debt. The average for the S&P 500 is 31%.

As we approach the 1250 S&P 500 near-term target that I have suggested over the past few months, I have begun to take some profits, reducing stock exposure to 70%.  Last month, when bonds fell below 10% (due to stock appreciation), we took the exposure to 14%.  At this point, I am inclined to allocate a little more towards bonds (from cash).  Don't get me wrong, bonds are probably no great bargain, but they aren't the one-sided bet they were a few months ago.  The 10-year Treasury yield closed today at 3.25%, down from 3.84% a year ago but up from 2.38% just two months ago.  Rates could rise to 4-4.25% over the next several months if we get signs of a sharply accelerating economy, but I don't expect that to be the case. If so, we should more than make up for it with the equity overweight.

Disclosure:  No stocks mentioned 

Special Dividends Like Never Before

With the potential for less favorable tax treatment ahead, companies have been announcing "special dividends" like never before.  Many of the companies are specifically citing "excess capital" , so I take these payments as a sign of confidence as well.  With many managers being measured these days on metrics like return on capital, it behooves the executives to lower the denominator by returning cash.  My guess is that this money will end up being reinvested to a great degree.  This table isn't meant to be a complete recitation of the many recent declarations, but it should give us a flavor:

 
I highlighted in dark green the dividends that exceed 10% of the market value of the company and in light green those between 5% and 10%.  As you can see, there are several substantial payments.  While the value of the stock drops immediately to reflect the dividend payment, to the extent this is really just extra cash and to the extent investors weren't incorporating it into their valuation (some do, many do not), shareholders could actually benefit as the stock ultimately recovers the drop from going ex-dividend.  This begs the question:  Who's next?

I don't have an easy way to produce a large list of names in a short amount of time, but I will share this clue:  Look for high insider ownership and excess cash.  One that comes to mind is National Presto (NPK), which has a tradition of making its large one-time dividends in March but that could accelerate it into 2010. Another one that comes to mind is Skecher's (SKX).  I don't think that the companies need to necessarily have the cash.  If they are underleveraged (as several on the list above were), they could still make a payment.  I think Flowers (FLO) is one that fits this description well.  Given that many of these stocks are rallying on the declarations of the special dividends, it makes sense to give it some thought.

Disclosure:  Long FLO and NPK in the Conservative Growth/Balanced Model Portfolio and long SKX in the Top 20 Model Portfolio at Invest By Model

21 Utilities Yielding More than 4.5% and Raising the Dividend

I received so much positive feedback on a recent look at obscure REITs that I decided to take a look at Utilities.  Clearly investors are interested in finding alternatives to low-yielding fixed-income securities.  While I continue to think that the best long-term answer is to invest in conservative and well-capitalized companies that can actually grow their dividends at a faster rate and are cheaper on a PE basis (and less leveraged financially), I understand why investors like REITs, MLPs and, as I address today, Utilities.  Before I share my results of a screen I run, I want to remind readers that I shared my favorable view on the sector in March.

Regulated Utilities have several risks, but they tend to be able to overcome them and ultimately pass their mistakes on to the users rather than investors.  Maybe that's too harsh, but we are talking about monopolies.  In my view, investors like REITs because they can grow their dividends faster typically than Utilities.  These days, that's less certain.  With that in mind, I ran a screen looking for attractive candidates in Utilities, but I decided to accept a lower yield than I did on the screen from this weekend with REITs.  Generally, with low rates expected to persist for years, I expect Utility dividend yields to push all-time lows.

Here are the parameters:

• Dividend Yield > 4.5% (this yielded 36)
• Market Cap > $100mm (this killed 1)
• Dividend Payout < 100% (this killed 4)
• At least three hikes in the past 5 years (this killed 10)

Here are the 21 that made the cut, sorted on dividend yield:

 

As you can see from the bottom line, the group yields typically 4.7% with 5% annually dividend growth.  The payout ratios are typically 57%, but some are paying out substantially higher.  Year-to-date, the group has returned typically 10%, in line with the market.  Note that over half have raised their dividend each of the past 5 years.

This is not an area that I have typically found to be worthy of much of my time for the two investment models I run, but I do get the chance to discuss Utilities regularly with one of my clients.  I also bought two, Allete (ALE) and Portland General (POR) in the Spring for my Conservative Growth/Balanced Model.  I had also put POR in my Top 20 Model Portfolio as the market was peaking.  At present, I continue to hold POR in the Conservative Growth/Balanced Model Portfolio.  I also had the chance to visit with  Northwestern (NWE) in South Dakota this summer and believe that they are well managed.

For investors looking for alternatives to fixed-income, I do expect Utilities to provide superior returns.  This list might be helpful in identifying potential investments, as I have tried to incorporate some evidence of potential sustainability.  One factor not captured is that there is a bit of a cyclical lift for some Utilities, as their industrial customers are again running their factories after slowdowns in 2009.  There are many other variables to investigate, particularly pending rate cases and the relationship of the Utility with its regulators.  Happy Hunting!

Disclosure:  Long POR in a model portfolio

 

9 Obscure REITs Yielding More than 5% with Low Leverage

Real Estate Investment Trusts (REITs) are soaring this year by any measure. The iShares Dow Jones Real Estate ETF (IYR) is up over 25% YTD, in stark contrast to the overall Financial sector for the S&P 500, which includes REITs and is up just 8.1% this year.

While I don't call myself an expert in the area, I do spend considerable time with a client discussing them on a weekly basis. I have noticed that most REITs have dozens or more analysts that follow them, but many aren't as widely followed. These are typically either smaller and/or a bit off-the-run (as you will see). I decided to investigate if there might be some reasonable offerings, so I ran the following screen:

• Dividend Yield > 5%
• Market Cap > $500mm
• Number of Analysts < 7
• Net Debt to Capital < 50%
• Leverage (A/E) < 2X

Here are the 9 names that met the criteria:

 

The list is consists names that are typically Small-Cap/Mid-Cap, ranging from $734mm to $3 billion in market cap. The typical yield is close to 6%, with a range of 5% to 7.5%. The typical net debt to capital ratio is close to 20%, which is very low for the industry. I included an additional metric of leverage (Assets/Equity) to help adjust for the size of preferred stocks or other types of liabilities that are typically present among REITs. I also included P/TB, as the metric is reasonably low for most of the group. Note that some of these stocks have done well, but they are typically lagging (at a median of 14% YTD, though with two actually down on the year).

I share this list mainly to serve as a starting point for readers interested in doing their own work. I do have a few comments, though, that I can share. Taking them in order:

My REIT-focused client discussed Getty (GTY) recently. It has the fewest analyst covering it of the group, mainly because its focus is so niche-oriented (gas stations). One thing to understand better is the relationship with Lukoil.

Government Properties (GOV) is also somewhat unique, focused on government-leased facilities. The company is a recent spin-out. I looked at it when it did the IPO last year and found the alignment with shareholders to be good despite the fact that they rely on outside management.

Entertainment Properties (EPR) too is rather unique, focusing mainly on movie theatres but also charter schools. They have stumbled in their diversification program and have run into a few other issues, but I like the CEO (based upon an interview I read). This one seems a bit extended but might make sense on a pullback.

Finally, National Health (NHI) is one I highlighted almost three years ago due to its very low leverage. It has performed remarkably well, rising to an all-time high. Not too many REITs can say that! Note that the dividend has increased about 18% over those three years. Not too many REITs can say that either!

So, hopefully this is helpful to those of you looking for yield but trying to avoid stepping on landmines. Relative obscurity and low-leverage just may be allowing investors a reasonable opportunity here.

Disclosure: None