High-Yield Stocks No Longer Pricey
This year we've commented several times about how expensive high-yield stocks look. Well, things change.
Over the last six months, the average dividend-paying stock in the S&P 1500 Index returned 13%, while the average nonpayer returned 17%. And within the ranks of dividend payers, the highest-yielding stocks delivered the weakest returns, averaging 4%.
While it's still tough to call high-yield stocks cheap in the wake of their poor performance, they no longer look particularly expensive. The top-yielding stocks in the S&P 1500 Index average Quadrix Value scores of 58, in line with the average for all dividend stocks and above the average for nonpayers
High-yield stocks still average Overall scores well below those of stocks with lower yields, and they tend to deliver lower dividend growth. However, they do offer other compensations. Based on standard deviation of monthly returns over the last 10 years, a measure of how widely returns are dispersed around the average, stocks in the top two quintiles (fifths) of the index as measured by yield were less volatile than those with lower yields. High-yielders average annual standard deviations of 8.4%, versus 9.7% for the three lower-yield quintiles.
While the high-yield space doesn't offer the best fishing, we have hauled a few choice selections out of that pond, including those in the table below. Four of the stocks are reviewed in the following paragraphs.
Fifth Third Bancorp ($20; FITB), like many banks, cut its dividend drastically during the financial crisis. The regional bank paid out $0.44 per share quarterly in early 2008 before reducing the dividend twice — to $0.15 and then to $0.01 — later that year. But since the start of 2011, the company has raised the payout five times, most recently a 9% boost to a quarterly payment $0.12 per share earlier this year. The stock now yields 2.4%.
We expect more dividend growth going forward, for at least two reasons:
• In the seven years before Fifth Third cut its dividend, it had grown the payout at an annualized rate of 12%. Recent hikes suggest the company would like to continue its dividend-raising ways.
• Fifth Third's payout ratio (dividends as a percentage of trailing earnings) is just 27%, leaving plenty of flexibility for future increases. From 2004 through 2006, the bank paid out an average of 50% of its profits in dividends.
Fifth Third doesn't just give back to stockholders via dividends. Over the last year, the bank has repurchased enough shares to lower the count by 6%. Trading at less than 12 times trailing earnings, a discount of 29% to the median regional bank in the S&P 1500 and 19% to its own five-year average P/E ratio, Fifth Third is a Buy and a Long-Term Buy.
Helmerich & Payne's ($80; HP) yield of 2.5% is among the highest for oil-and-gas drillers in the S&P 1500 Index, well above the industry average of 1.4%. Credit a pair of massive increases (to $0.15 per share quarterly from $0.07 per share in December, then to $0.50 per share in June) for the generous yield.
H&P said it intends to continue raising the dividend, though another massive jump seems unlikely. The contract driller has reduced its capital spending over the last year, funding the dividend hikes through its robust operating cash flow without adding any debt.
Growth expectations are moderate but rising. Since announcing September-quarter sales and profits that topped estimates and providing a cautiously optimistic outlook on demand for new rigs, the consensus per-share-profit estimate has risen 4% for the fiscal year ending September 2014 and 10% for fiscal 2015. H&P is a Focus List Buy and a Long-Term Buy.
U.S. Bancorp ($39; USB) has more than quadrupled its quarterly dividend from the $0.05 it paid during 2009 and 2010. While the dividend hasn't climbed to prerecession levels, U.S. Bancorp's payout ratio of 31% suggests more growth is in store. The company is augmenting its dividends with share buybacks, reducing the share count by 3% over the last year.
Like many other banks, U.S. Bancorp has seen improving credit quality and decent loan growth in recent months. In the September quarter, average loans rose 2% from the June quarter and 6% year-over-year, paced by a 9% year-over-year increase in commercial loans. The home-mortgage slowdown shouldn't affect U.S. Bancorp as much as many of its peers, as only 21% of its loans are backed by residential real estate, versus an average of 35.6% for the three largest U.S. mortgage lenders.
At 13 times trailing earnings, the bank trades at an 18% discount to its five-year average P/E and 20% below the median for bank stocks in the S&P 1500. U.S. Bancorp, yielding 2.4%, is a Long-Term Buy.
Despite a slowdown in the mortgage business, the consensus projects Wells Fargo ($44; WFC) will grow per-share profits 7% in the December quarter and 4% next year. The financial giant has topped the profit consensus in each of the last eight quarters, and even a modest uptick in economic growth could drive growth above the modest expectations.
In the September quarter, Wells Fargo's credit quality continued to improve, with annualized net charge-offs down to 0.48% of total loans from 0.58% in the June quarter and 1.21% in the year-earlier period. The loan portfolio grew 1% from the June quarter and 5% from the September 2012 quarter despite weakness in the residential-mortgage business.
Wells Fargo's quarterly dividend has tripled since the March 2012 payment, with the most recent action a 20% hike in April 2013. Given Wells Fargo's success at convincing the Federal Reserve to allow higher payouts, further dividend increases seem likely. Wells Fargo, yielding 2.7%, is a Focus List Buy and a Long-Term Buy.
Medians make the difference
The question of whether yield works as a predictor of future stock returns has no definitive answer. More specifically, we could support both yes and no answers.
Consider 12-month returns for S&P 1500 Index stocks since 1994, grouped by yield. The average return of the top quintile (one-fifth) of the index as measured by yield lagged the average stock by 0.4%. But the median stock in the top quintile outperformed the median stock in the index by an average of 2.0%. By definition, half of the points in a data set are higher than the median, and half are lower.
Based on median returns, top-yielding stocks outperformed in two-thirds of the last 18 calendar years. Based on average returns, top-yielders underperformed more than two-thirds of the time.
We find a discrepancy between outperformance based on medians and averages in every Quadrix statistic, but the average variation between the two is just 0.5%, and averages deliver superior returns with about two-thirds of the statistics. Among the more than 180 statistics we pull in six categories (not all are used to calculate the Quadrix score), yield sees the greatest gulf between the underperformance based on averages and the outperformance based on medians.
Why the big difference? We attribute it to the nature of yield variations. Outperformance based on average returns depends in a larger part on outliers, the relatively small number of stocks that deliver huge returns. The top one-fifth of stocks based on yield tends to have fewer huge winners.
We generally consider outperformance based on average returns because outliers matter. But it's important to know how much a strategy's track record depends on few huge gainers, especially if you use fairly focused portfolios like us.
Over long periods, outliers also drive portfolio returns for individuals, and a few truly impressive winners can make the difference between a portfolio that leads the market and one that lags. That is one reason we don't rely primarily on yield when selecting stocks for our buy lists.