A High-Yield Alternative

2/13/2012


Based on what we hear from subscribers, everyone seems to love high-yield stocks. But what exactly qualifies as a high-yield stock nowadays?

At the start of 1990, fully 20% of the dividend-paying stocks in the S&P 500 Index yielded more than 5.9%. Today, fewer than 2% of the index's dividend payers have yields that high. Investors who expect yields of 6% — or even 4% — from their stock portfolios have few options. As of Feb. 7, only 53 S&P 500 components yielded more than 4%.

But dividend growth is surging, and investors willing to set their yield bar lower can create a diversified portfolio of high-quality stocks that generate solid income. Last year, Standard & Poor's said the roughly 7,000 public companies that report dividend information announced a total of 1,953 positive dividend actions — increases, resumptions, or extra payments — up 13% from 2010 levels and the highest number since 2007. The trend continued in January with 223 positive dividend actions, a 38% increase over the year-earlier month.

Dividend growth in 2011 still lagged activity in the middle of the 2000s. Going forward, we expect companies to continue raising their dividends. That is good news for income-oriented investors, though it does not mean yields will regain their former glory.

The S&P 500 Index's quarter-end yield has averaged just 2% over the last 20 years — including the period in 2008 and 2009 when yields jumped because stock prices slumped. The days when a wide variety of high-quality companies consistently yielded 4% or more are probably history. And at the moment, the highest-yielding stocks don't look so good, anyway.

The top quintile of the S&P 500 Index as measured by yield, which today comprises all index stocks yielding 3.1% or higher, averages a Quadrix Overall score of 49, well below the average of 61 for the entire index. The median stock in the highest-yielding quintile trades at 15 times trailing earnings, roughly in line with the median for all stocks in the index. But the high-yielders look expensive relative to their average valuation since the end of 1994, while the broad index's stocks tend to trade at a discount.

SECTOR ANALYSIS
Avg. Dividend
------- Yield -------
Avg. Dividend
------ Growth ------
Sector (No. Of Cos)
No. Of
Dividend
Payers
% Of
Dividend
Payers
Current
(%)
1 Year
Ago
(%)
3 Years
(Annual.)
(%)
10 Years
(Annual.)
(%)
Cons. Discretionary (80)
58
73
1.5
1.3
10
23
Consumer Staples (42)
40
95
2.7
2.7
10
17
Energy (43)
33
77
1.1
1.0
4
19
Financials (81)
73
90
2.0
1.6
(15)
8
Health Care (52)
28
54
1.0
0.9
27
18
Industrials (61)
57
93
2.1
1.8
11
18
Materials (30)
29
97
1.8
1.5
11
18
Technology (71)
37
52
1.0
0.8
15
20
Telecom Services (7)
5
71
6.3
4.9
25
24
Utilities (33)
31
94
3.9
4.2
6
15
S&P 500 Index (500)
391
78
1.8
1.6
6
16
Average growth excludes stocks that don't pay dividends or didn't three or 10 years ago.

We find a lot of attractive stocks in the 2% to 3% yield range. The table below lists 18 A-rated stocks yielding at least 2%, a diversified group of high-yield companies, all with a history of growing their dividends. Four of those stocks are reviewed below:

Intel ($27; INTC) provides investors with a rare blend of attractive valuation and strong share-price action, scoring above 80 for both Value and Performance. It is also one of just four S&P 500 technology stocks yielding more than 3.0%.

The balance sheet holds $14.84 billion in cash versus $7.08 billion in long-term debt. In terms of capital allocation, Intel places the most emphasis on reinvesting in its business (capital spending is projected to grow about 16% to $12.5 billion in 2012), followed by dividend growth (spending up 19% last year), and then share repurchases (share count down 8% in 2011). The dividend accounted for 40% of free cash flow last year, a ratio Intel seeks to maintain.

Emerging markets drive Intel's growth, as China has become the sector's largest market for both smartphones and personal computers. Intel says PC production is near a bottom and expects a rebound, especially in the second half of 2012. Intel is a Focus List Buy and a Long-Term Buy.


Microsoft ($30; MSFT) shares have risen 17% so far this year, easily outpacing the 7% gain posted by the S&P 500 Index. But the stock still yields 2.6%, well above its five-year average of 2.0%. Microsoft raised its dividend 20% last year, after a 23% hike in 2010.

Yet investors clamor for even more dividend growth, and Microsoft seems capable of delivering.  Free cash flow rose 14% to more than $21 billion in the 12 months ended December. And cash on the balance sheet has swelled to $51.74 billion, up 25% from a year ago, though about 89% is held offshore. Long-term debt stands at just $11.93 billion, and Microsoft could tap its AAA credit rating to secure more cheap debt if desired. IBM ($193; IBM), with a bond rating below that of Microsoft, sold three-year bonds with an interest rate of just 0.55% in February, the lowest rate since Dealogic began tracking such information. Microsoft is a Buy and a Long-Term Buy.


Rogers Communications ($39; RCI) controls roughly 36% of Canada's wireless market and 30% of the cable-TV market. Although growth in both industries has slowed in recent years, Rogers produced $2.75 billion in cash from operations for the first nine months of 2011, up 6% and a record for the first three quarters of a fiscal year. Free cash flow totaled $785 million, and management expects strong cash generation to continue. Rogers figures to be an active bidder in an upcoming spectrum auction, likely to occur in late 2012 or 2013.

The company delivers consistent dividend growth, boosting the payout by at least 10% in each of the past six years. Rogers typically announces these hikes in the first two months of the year. Rogers may also use some of its excess cash for stock buybacks, which have reduced the share count by 14% since March 2009.

For the December quarter, the consensus calls for flat earnings per share of $0.64 on 1% revenue growth. Scheduled to report its results on Feb. 22, Rogers is a Long-Term Buy.


Wal-Mart Stores ($62; WMT) pays out about one-third of its earnings in dividends, the payout ratio rising in eight of the last nine years from 17% in the fiscal year ended January 2003. The dividend has grown every year since its inception in 1974, and Wal-Mart usually announces hikes in February.

For the January quarter, Wal-Mart is projected to report per-share profits of $1.46, up 9%, on 7% revenue growth. Management expects same-store sales for its U.S. stores be flat to up 2%. The retailer hopes to build on a 1.3% gain in the October quarter, which had ended a streak of nine consecutive quarters of lower same-store sales.

Wal-Mart is notoriously closemouthed about its sales, and we will not learn what happened during the holiday season until the company reports January-quarter profits Feb. 21. At less than 13 times estimated year-ahead earnings, the stock trades at an 8% discount to its peer group. Wal-Mart Stores is a Long-Term Buy.

STOCKS WITH SOLID YIELDS
Below we present A-rated (above average) stocks that yield at least 2%, pay out no more than 50% of their earnings in dividends, and have a history of dividend growth. Stocks on our buy lists are presented in green.
Dividend
---- Growth ----
Quadrix
---- Scores * ----
Company (Price; Ticker)
Div.
($)
Yield
(%)
Payout
Ratio
(%)
3 Yrs.
(Ann.)
(%)
10 Yrs.
(Ann.)
(%)
Value
Overall
Sector
Abbott Labs.
($56; ABT)
1.92
3.4
41
13
17
78
72
Health Care
Accenture
($58; ACN)
1.35
2.3
38
48
NA
55
78
Technology
Aflac ($49; AFL)
1.32
2.7
21
14
30
95
96
Financials
Applied Mats.
($13; AMAT)
0.32
2.5
25
10
NA
91
94
Technology
Best Buy ($25; BBY)
0.64
2.5
20
9
NA
99
84
Discretion.
BlackRock
($189; BLK)
5.50
2.9
46
24
NA
72
97
Financials
Chevron ($107; CVX)
3.24
3.0
24
11
17
91
88
Energy
ConocoPhillips
($72; COP)
2.64
3.7
30
14
23
91
69
Energy
CSX ($22; CSX)
0.48
2.2
29
32
17
75
72
Industrials
Exxon Mobil
($86; XOM)
1.88
2.2
22
9
16
89
80
Energy
Gen'l Dynamics
($71; GD)
1.88
2.6
26
16
21
87
73
Industrials
Intel ($27; INTC)
0.84
3.2
33
19
36
85
98
Technology
Microsoft
($30; MSFT)
0.80
2.6
29
23
NA
81
89
Technology
Norfolk Southern
($72; NSC)
1.88
2.6
35
20
32
73
83
Industrials
Rogers Commun.
($39; RCI) e
1.40
3.6
47
51
50
78
86
Telecom
Union Pacific
($115; UNP)
2.40
2.1
36
45
28
53
95
Industrials
Valero Energy
($25; VLO)
0.60
2.4
14
6
31
99
63
Energy
Wal-Mart Stores
($62; WMT)
1.46
2.4
33
18
35
67
87
Staples
* Percentile ranks, with 100 the best.    NA Not Available.     e  Estimated.

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