Dividend stocks for low excitement, high returns

The Basics

Dividend stocks for low excitement, high returns
Boring? Maybe. But here's a screen for finding dividend stocks that will have you yawning all the way to the bank.


By Harry Domash (Author of "Fire Your Stock Analyst")

It's time to make the case for "boring" dividend stocks.

From a tax perspective, they're hard to beat: Thanks to recent tax-law changes, most dividends are taxed at only 15%. Previously, dividends were hit at full income-tax rates.

And these stocks have been anything but boring when it comes to returns. According to Standard & Poor's, dividend-paying companies returned 18.4% last year, compared with 13.7% for those that didn't pay dividends and 8.6% for the Nasdaq, home to so many of the tech stocks investors find so exciting.

I've devised a screen for finding promising -- and, yes, boring, but only in the sense that they won't keep you up at night -- dividend-paying candidates. The screen pinpoints well-established companies that have solid earnings and dividend growth track records.

You won't get-rich-quick with these stocks. But most are expected to grow earnings between 10% and 15% annually over the next five years. So, over time, you can expect their share prices to move up at about the same rate. Combine that expected -- though by no means guaranteed -- price appreciation with 2% to 5% dividend yields, and you can expect annual returns in the 12% to 20% range, or roughly 16% per year.

To put that in perspective, at a 16% compounded annual return, $1,000 turns into $2,100 in 5 years. The S&P 500 ($INX) managed less than an 11% average annual return, and the Nasdaq Composite ($COMPX) returned around 4% over the past 10 years.

I've intentionally excluded higher-yielding stocks such as mortgage REITs (real-estate investment trusts that invest in mortgages) and royalty trusts (trusts, frequently based in Canada, that invest in oil and natural-gas resources) that often pay dividends equating to double-digit yields. These may be worthwhile investments, but require special analysis that I don't have room to cover here.

Here's how the screen works. You can use it as is, or as a starting point which you can revise to suit your needs.

Dividend yield: Set upper limits, too

If you're rusty on your stock-market math, dividend yield is a company's next 12 months' dividends divided by its current share price. For example, your yield would be 10% if you paid $10 per share for a stock expected to pay out $1 per share over the next year ($1/$10). However, another investor's yield would only be 9.1% if he bought the same stock a week later for $11 per share ($1/$11).

I arbitrarily set my minimum yield at 2.25%, which was the prevailing return on low-risk money market funds when I researched this column. Obviously, the lower the minimum yield, the more stocks you'll get. For example, 1,688 U.S.-listed stocks currently pay at least 2.25%. But reducing the minimum to 1.5% increases the field to more than 2,200 stocks.

Screening Parameter: Current Dividend Yield >= 2.25

For dividend yield, higher is not always better. High-yielding stocks get that way because many investors see them as risky.

Think about it.

Say a stock is expected to pay $1 per share in dividends over the next year and is changing hands at $10 per share, equating to a 10% yield. Given current money market rates, buyers would flock to buy a stock yielding 10% if they thought the dividend was rock-solid. The buying pressure would push the share price up until the yield dropped closer to market rates. In my experience, stocks with dividends seen as safe don't trade at yields much above the 4% to 4.5% range.

So I set my maximum acceptable dividend yield at 5%. Increase the maximum to 8% if you want to see riskier stocks. Sometimes cigarette makers such as Altria Group (MO, news, msgs) pay yields in the 7% range.

Screening Parameter: Current Dividend Yield <= 5

Look for dividend growth
You win two ways if one of your stocks ups its dividend. The higher payouts increase your yield and the dividend hike usually drives the share price higher.

History is truly the best teacher when it comes to evaluating dividend growth prospects. Companies with a record of strong historical dividend growth usually are committed to continuing that policy. Conversely, companies that haven't consistently increased dividends probably prefer to use their extra cash for other purposes.

I require at least 5% average annual dividend growth over the past five years. Ideally, you'd like to see even higher growth, but the recent recession prevented many firms from increasing their payouts. Increase the requirement to 7% or 8% if your screen turns up too many candidates.

Screening Parameter: 5-Year Dividend Growth >= 5

Profits power dividends

Since dividends come from earnings, you should draw your dividend candidates from the ranks of profitable companies. Return on equity (ROE), which is net income divided by shareholders equity (book value), is a widely used profitability gauge. But profitability standards vary between industries. So instead of setting an arbitrary minimum, I require that passing candidates must at least equal their industry average ROE.

Screening Parameter: Return on Equity >= Industry Average ROE

Stick to the strongest banks

Banks have been good dividend-payers in recent years, so my first try using this screen turned up several bank stocks. However, many small or regional banks enjoyed exceptionally strong profits from making and servicing home mortgages. Rising interest rates are squeezing their mortgage profit margins and reducing the demand for new mortgages. So this phase of the economic cycle is not the time to bet heavily on banks.

The leverage ratio measures debt by dividing total assets by shareholder's equity, and it's useful here. A company with no debt would have a 1.0 leverage ratio. The higher the debt, the higher the ratio. Banks are often highly leveraged, many with ratios in the 10-to-15 range, which is understandable, considering that cash is a bank's inventory.

I set my maximum allowable leverage at 10, in order to find only those banks with relatively strong balance sheets. Adjust that limit up if you want your screen to turn up more banks, and down for fewer banks.

Screening Parameter: Leverage Ratio <=- 10

Avoid future losers

A company like General Motors (GM, news, msgs) may have great dividend history, but a dismal outlook. In fact, many analysts expect GM to cut its dividend in the not-too-distant future.

You don't need to spend your time evaluating each candidate's future prospects because stock analysts do that all day long. So I piggyback on their efforts and rely on analysts' long-term earnings forecasts and buy/sell recommendations to rule out stocks likely to cut future dividends.

First, since dividends come from earnings, I look for consensus forecasts calling for at least 10% minimum average annual earnings growth over the next five years. Even if the forecasts are wrong, the likes of GM and Eastman Kodak (EK, news, msgs) are unlikely to pass this test.

Screening Parameter: EPS Growth Next 5Yr >= 10

As a backup check, I also look at analyst's consensus buy/sell recommendations.
Something's fishy if analysts are forecasting strong long-term earnings growth, but advising investors to sell the stock. Dividend investing is about avoiding unnecessary risk. It doesn't make sense to consider stocks that analysts say you should sell.

Screening Parameter: Mean Recommendation >= Hold

Follow the pros

Institutional buyers such as mutual funds and pension plans more tuned-in to what's happening in the market than you and I will ever be. If the big boys won't own a stock, we shouldn't either.

Institutional ownership is measured as a percentage of outstanding shares and can range from zero to 95%. There's no cast-in-concrete number that says a stock has enough institutional ownership. As a rule of thumb, I set a 40% minimum. Reduce the minimum to as low as 30% if you don't get enough candidates.

Screening Parameter: % Institutional Ownership >= 40

My screen turned up 19 stocks in a variety of industries. The list included one savings and loan and three regional banks. However, MBNA (KRB, news, msgs), which is listed as a regional bank, is primarily a credit card issuer. As always, the results of this or any screen should be considered research candidates, not a buy list.

Dividend Winners

Company----Price*----Industry

Abbott Laboratories (ABT, news, msgs)
47.2
Drug manufacturers - major

Allstate (ALL, news, msgs)
54.63
Property & casualty insurance

Autoliv (ALV, news, msgs)
46.9
Autoparts

Avery Dennison (AVY, news, msgs)
61.21
Paper & paper products

Bemis (BMS, news, msgs)
31
Packaging & containers

Eaton Vance (EV, news, msgs)
23.08
Asset management

Fidelity National Financial (FNF, news, msgs)
32.45
Surety & title insurance

General Electric (GE, news, msgs)
35.5
Conglomerates

Harbor Florida Bancshares (HARB, news, msgs)
33.59
Savings & loans

Kinder Morgan (KMI, news, msgs)
76.24
Gas utilities

Limited Brands (LTD, news, msgs)
24.65
Apparel stores

Lincoln Electric Holdings (LECO, news, msgs)
29.56
Machine tools & accessories

Masco (MAS, news, msgs)
34.65
Industrial equipment & components

MBNA (KRB, news, msgs)
24.9
Regional - mid-Atlantic banks

PartnerRe (PRE, news, msgs)
64.27
Property & casualty insurance

Spartech (SEH, news, msgs)
19.32
Rubber & plastics

Synovus Financial (SNV, news, msgs)
27.78
Regional - mid-Atlantic banks

U.S. Bancorp (USB, news, msgs)
28.57
Regional - Midwest banks

Worthington Industries (WOR, news, msgs)
19.2
Steel & iron

*Price of position at the time of original publish date.

Even though these stocks look good now, circumstances change over time. Check your stocks every six months or so, and sell any that analysts are advising selling or that no longer have strong long-term earnings-growth forecasts.

At the time of publication, Harry Domash did not own or control positions in any of the stocks mentioned in this article. Domash publishes the Winning Investing stock and mutual fund advisory newsletter and writes the online investing column for the San Francisco Chronicle. Harry has two investing books out, the most recent being "Fire Your Stock Analyst," published by Financial Times Prentice Hall.

http://articles.moneycentral.msn.com/Investing/InvestingForIncome/DividendStocksForLowExcitementHighReturns.aspx

In This Market, Dividends Look Great

OCTOBER 19, 2008
In This Market, Dividends Look Great
By GREGORY ZUCKERMAN


The brutal drops in stock prices in recent weeks have devastated investors' portfolios. That's the bad news.

The good news: The stock-market plunge has also made a number of quality companies paying hefty dividends much cheaper -- boosting their "dividend yield," or the annualized dividend as a percentage of the stock price. That has some analysts recommending these shares to investors eager for some ballast in a rough market.

Indeed, stocks such as Coca-Cola, Altria Group and Merck sport dividend yields ranging from 3.4% to 6.6% and are considered relatively safe picks even in a painful global recession.

But some high-dividend stocks can be dangerous, especially as corporate profits fall, cash flows shrink and companies find it more difficult to make these payments to shareholders. Dividends generally are the second expenditure that companies trim to conserve cash in a downturn, after stock buybacks. Some investors piled into Bank of America in the past few months, attracted by a dividend yield that topped 7%. But earlier this month, the bank slashed its dividend in half, sending its shares lower.

Look Beyond Yields

In selecting stocks, "a pure dividend view misses the risk of earnings adjustments that could force future dividend cuts," says Tobias Levkovich, Citigroup's chief U.S. equity strategist. "There is lots of risk for industrial, energy and materials firms that likely will suffer margin deterioration as the global economy slows and internal cash needs grow.

"Conversely," he adds, "financial and health-care companies may be in a far better position, as many diversified financial stocks already have gone through dividend reductions, while health-care entities are generally less cyclical."

Last week, stocks went on a roller-coaster, soaring on Monday, tumbling later in the week, and finishing the week with the Dow Jones Industrial Average up 4.8%.

The turbulence makes companies that pay a reliable, hefty dividend much more attractive. Coca-Cola, for example, has a 3.4% yield and has been on a roll, despite the weakening global economy. Coke posted better-than-expected third-quarter profit growth of 14%, as strong growth from international markets helped offset weakening U.S. beverage sales. About 81% of Coke's profit came from foreign markets last year, and the company has expanded in emerging markets. Coke's revenues from Latin America, a relative bright spot in the globe, jumped 24% in the third quarter.

Drug companies like Merck have had more challenges, amid a paucity of blockbuster new drugs and a weakening dollar. But Merck now trades for less than nine times its 2009 expected earnings, and its dividend -- producing a yield of 5.3% -- is viewed as relatively safe.

Consider Utilities

Although utilities' shares have fallen sharply, some investors and analysts see their dividends as stable, and argue that the shares could be strong because they will outperform in a downturn. Goldman Sachs recommends American Electric Power, Consolidated Edison and Entergy. These stocks have dividend yields between 3.7% and 6%.

Whitney Tilson, who helps run hedge fund T2Partners, is a fan of tobacco maker Altria, which has a 6.6% dividend yield and may not see much of a sales slump in a downturn.

He also likes Crosstex Energy LP, a master limited partnership that operates natural-gas pipelines and processing and treatment plants. The stock has tumbled 57% in the past year, but the dividend has risen to an annualized $2.52, for a yield of 17.3%. Mr. Tilson says he expects the payout won't be cut.

Freeport-McMoRan Copper & Gold has a 6.1% dividend yield and trades for less than five times its expected 2009 earnings. The catch? It has suffered as commodity prices have plunged. Shares have been dumped by hedge funds -- former fans of the stock that have found themselves under heavy pressure lately and eager to raise cash. Any stabilization of commodity prices likely would leave the company in a strong position, analysts say.

But investors should be careful about high-dividend payers. Some analysts say investors should be wary before buying shares of CIT Group, a lender that sports an 8.5% dividend yield, because the company could see rougher times in the months ahead. The company cut its annualized dividend from $1 to 40 cents earlier this year.

A CIT spokesman says "the dividend is paid at the Board's discretion and serves as an indication of their confidence in CIT's long-term earnings potential."

'Unsustainable' Dividend

Another stock to be wary of: McClatchy, a newspaper company with a dividend yield of 10.2%, even after recently halving its payout. "Their dividend is unsustainable and will likely be cut" again, says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "It's a tough business, in this environment especially."

Richard Tullo, an independent analyst, also is concerned about whether New York Times and Eastman Kodak can continue to pay dividends producing yields of 7.4% and 4.1%, respectively. The Times's "rich dividend may be sacrificed, as earnings will remain weak and as the company will have to move to strengthen its balance sheet," Mr. Tullo says, adding that Kodak's dividend could be cut as the company diversifies into new businesses.

Representatives of McClatchy, New York Times and Kodak declined to comment.

Mr. Tilson urges continued caution regarding many financial shares. "We would stay away from almost all high-yielding financials," he says. A high dividend yield for a bank or other firm under pressure "indicates the skepticism investors have that the company will stay alive…. Also, the government could force them to eliminate the dividend" to conserve needed cash.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com

http://online.wsj.com/article/SB122438121647847893.html

Outyielding Blue Chips

Browsing the business section of the local paper enabled one to pick up stocks with dividend yields of 4.0% or greater.

No intelligent investor, no matter how starved for yield, would ever buy a stock for its dividend income alone; the company and its businesses must be solid, and its stock price must be reasonable.

But, thanks to the bear market that began the last few months, some leading stocks (blue chips) are now outyielding FDs.

So, even the most defensive investor should realize that selectively adding stocks to an all-bond or mostly-bond portfolio can increase its income yield - and raise its potential returns.

Ref: modified version based on Intelligent Investor by Benjamin Graham

Understanding Stock Market Return

Stock market return

= fundamental return + speculative return

= (earnings growth + dividend yield) + (change in PE ratio)

http://turtleinvestor888.blogspot.com/2008/03/is-there-such-thing-call-value_19.html