Yield Of Dreams, Or A Nightmare?

7/14/2014


Big dividend yields can blind investors to stocks' underlying risks. Consider this a warning: Yield should not be the only consideration in your investment process.

The top two S&P 1500 sectors by average yield of dividend payers — telecommunication services at 5.7% and utilities at 3.4% — also have the lowest average dividend growth over the past three years, as shown below.

TOUGH TO FIND YIELD AND GROWTH TOGETHER
The two S&P 1500 sectors with the highest average yields also have the lowest average dividend growth over the past three years.
-- Dividend Payers --
Average Yield
Of Dividend
Payers
(%)
Average 3-Year
Annualized
Dividend
Growth
(%)
S&P 1500 Sector
Number
% Of
Sectors
Consumer Discretionary
144
60
2.0
23
Consumer Staples
58
78
2.2
10
Energy
57
61
1.7
16
Financials
259
90
2.8
21
Health Care
56
23
1.7
16
Industrials
175
80
1.5
12
Materials
83
82
1.7
17
Technology
102
40
1.9
24
Telecommunication Services
10
67
5.7
(6)
Utilities
61
100
3.4
5
S&P 1500 Index Average
1,005
67
2.2
17

Drilling down further, among S&P 1500 industry groups with at least five dividend-paying stocks, many of those with the highest average yields are plagued by weak dividend growth and low Overall scores, as shown below.

Such lackluster growth is just one problem for investors who pursue yield at the expense of other considerations. It can also lead investors to become unduly concentrated in a small group of industries.

TOP 10 S&P 1500 INDUSTRIES BY DIVIDEND YIELD
Among S&P 1500 industries with at least five dividend-paying stocks, the integrated telecommunications services industry has the highest average yield. But like many of the industries with the highest yields, dividend growth has been disappointing. Additionally, just a handful of stocks hailing from these sectors enjoy both reasonable dividend yields and high Overall scores.
Average
Yield
(%)
Average
3-Year
Annual.
Dividend
Growth
(%)
-- Quadrix Scores --
No. Of
Stocks
Yielding
Above 2%
& Overall
Above 80
10 Top-Yielding
S&P 1500 Industries
No. Of
Dividend
Payers
Value
Overall
Integrated telecom svcs.
6
5.7
(3)
78
58
1
Tobacco
5
4.2
10
52
51
0
REITs
82
4.0
11
35
43
3
Electric utilities
24
3.6
3
75
67
4
Diversified utilities
20
3.5
5
69
67
1
Thrifts & mtg. finance
12
3.4
2
65
48
0
Gas utilities
13
3.2
5
72
65
4
Oil & gas drilling
8
2.8
24
78
66
2
Tech consulting & services
6
2.5
0
65
52
2
Consumer finance
6
2.5
51
81
87
1
S&P 1500 avg. for dividend payers
1,015
2.2
17
60
62
90

 

TOP INDUSTRIES FOR YIELD AND OVERALL SCORES
The following S&P 1500 industries contain at least three stocks that yield more than 2% and earn an Overall score above 80.
No. Of
Dividend
Payers
Avg.
Yield
(%)
Avg.
3-Yr.
Annual.
Dividend
Growth
(%)
No. Of Stocks W/
Overall Above 80
And . . .
No. Of Stocks W/
Overall Above 90
And . . .
S&P 1500 Industry
Yield
Above
2%
Yield
Above
2.5%
Yield
Above
2%
Yield
Above
2.5%
Aerospace & defense
20
1.6
14
3
1
0
0
Asset management
17
2.0
35
5
2
1
0
Electric utilities
24
3.6
3
4
4
0
0
Gas utilities
13
3.2
5
4
2
1
0
Life & health insurance
10
1.8
35
4
1
1
0
Packaged foods & meats
24
2.1
3
3
2
0
0
Property & casualty insurance
26
2.4
10
10
4
8
3
Regional banks
67
2.3
36
5
3
1
0
REITs
81
4.0
11
3
3
1
1

Picking stocks with high yields hasn't always been a winning strategy. The top-yielding quintile of the S&P 1500 Index has underperformed the average stock in the index by an average of 6.8% in the last 14 rolling 12-month periods. Top-yielders have also underperformed slightly over the past 10 years and since the end of 1994.

However, opportunities exist if investors are willing to scale back their yield requirements and limit themselves to high-potential stocks, such as those with high Quadrix Overall scores. To qualify for the top quintile of the S&P 1500, a stock must yield 2.7%, roughly in line with the average of 2.6% since the end of 1994. Of the 182 dividend payers in the 10 industries with the highest average yield, 17 earn an Overall score above 80 and yield more than 2.0%.

Two of the top-yielding industries, electric and gas utilities, offer a relative abundance of stocks with decent yields and high Quadrix Overall scores. Other industries, mostly from the financial sector, also provide fertile ground for income investors seeking high-quality stocks.

We recommend that income-oriented investors also consider a company's capacity to grow the dividend, as well as other indicators of investment appeal that get rolled up into the Overall score. In the table below, we highlight stocks on our buy lists and members of the Top 15 Utilities portfolio that score above 80 for Overall and pay yields above 2.0%. Most boast solid dividend-growth histories. Five of our favorites are profiled below.

Dow Chemical's ($51; DOW) yield of 2.9% is tops among the diversified chemical companies in the S&P 500 Index. In the four quarters ended March, Dow Chemical generated $7.95 billion in operating cash flow (up from $4.57 billion in the year-earlier period) and $3.46 billion in free cash flow (up from $254 million), providing plenty of flexibility for continued growth.

Last month, Dow began construction on an expansion for an ethylene plant in Texas, the latest step in an ongoing $4 billion investment in ethylene and propylene production on the Gulf Coast designed to take advantage of low-cost natural-gas feedstocks. Analysts expect per-share-profit growth of 19% this year and 22% next year, reflecting a modest improvement in global industrial activity, augmented by cost cuts and efficiency improvements. Dow, which earns at least 84 in both of our Quadrix sector-specific scores, is a Focus List Buy and a Long-Term Buy.


Helmerich & Payne ($116; HP) earns an Overall score of 96, with four of the six category scores above 90, a feat managed by fewer than 1% of the stocks in our Quadrix universe of nearly 5,000. Consensus estimates project per-share-profit growth of 12% this year on 9% sales growth and 14% next year on 12% sales growth. Analysts expect H&P to grow profits at an annualized rate of nearly 16% over the next five years as the company parlays its young, efficient fleet of rigs into market-beating operating results.

So far this year, H&P has announced contract to build 53 new FlexRigs. The company's FlexRigs offer a technological advantage that allows the company to drill wells faster and charge more per day.

H&P more than tripled its quarterly per-share dividend to $0.50 in June 2013 and has raised it twice since them, most recently a 10% boost last month. Helmerich & Payne, yielding 2.4%, is a Buy and a Long-Term Buy.


In the three years ended March, Packaging Corp. of America ($69; PKG) grew sales at an annual rate of 20%, per-share profits 26%, and operating cash flow 18%. Over that same period, the dividend rose at a 36% annual clip.

Dividend growth could slow in the near term because PCA may opt to focus on debt reduction. In the wake of the company's $2 billion acquisition of papermaker Boise in October, PCA holds $2.50 billion in long-term debt, equating to 64% of total capital. Fortunately, the packaging company generates sufficient cash flow to both reduce debt and increase dividends.

The consensus projects per-share-profit growth of 42% this year on 60% sales growth, helped by the acquisition. At 15 times the 2014 profit target, PCA trades at an 11% discount to the median paper packaging company in the S&P 1500 Index. Packaging Corp. is a Buy and a Long-Term Buy.


UGI ($51; UGI), a seller of propane and provider of natural gas to about 600,000 customers in Pennsylvania, has raised its dividend in each of the last 27 years, most recently a 4% hike in April. The utility yields 2.3%, paying out just 39% of its earnings in dividends.

Early this month, UGI announced plans to pay at least $547 million for a liquefied-petroleum-gas distributor in France, bolstering an international business that already accounts for 30% of revenue. UGI's nonregulated operations give the company better growth potential than a traditional utility, with the consensus projecting per-share-profits 20% higher this year (helped by the acquisition) and nearly 8% annually over the next five years. UGI is a Buy and a Long-Term Buy, as well as a component of our Top 15 Utilities portfolio.


Banking giant Wells Fargo ($52; WFC) yields 2.7%, and will probably keep boosting the dividend for at least two reasons:

1) Over the last three years, Wells Fargo has grown its payout at an annualized rate of 64%. The company cut the dividend 85% in 2009 but has grown it aggressively since 2011 and seems likely to continue that growth if the Federal Reserve allows it.

2) From 2004 through 2008, the five years before the market meltdown that gobbled up bank dividends, Wells Fargo averaged a yield of 3.4%. Such consistently high yields reflect a desire on the part of management to share cash with stockholders.

Wells Fargo has raised its dividend three times since the start of 2013, most recently a 17% hike in April. The current per-share payout of $1.40 per year ($0.35 per quarter) equates to just 35% of expected 2014 earnings, leaving plenty of room for growth. Wells Fargo is a Focus List Buy and a Long-Term Buy.

TOP FORECASTS DIVIDEND PICKS
Ten stocks from our buy lists or the Top 15 Utilities portfolio offer yields above 2% and Overall scores exceeding 80.
Indicated
Dividend
(%)
Yield
(%)
3-Yr.
Annual.
Dividend
Growth
(%)
Dividend
Payout
Ratio
(%)
--------- Quadrix Scores ---------
Company (Price; Ticker)
Momen-
tum
Value
Overall
S&P 1500 Industry
AGL Resources ($55; GAS)
1.96
3.6
2
47
65
93
89
Gas utilities
Avista ($33; AVA)
1.27
3.9
6
65
77
80
87
Diversified utilities
Cisco Systems ($25; CSCO)
0.76
3.0
127
37
51
87
94
Communications equip.
Dow Chemical ($51; DOW)
1.48
2.9
29
57
68
72
87
Diversified chemicals
Helmerich & Payne ($116; HP)
2.75
2.4
98
47
85
53
96
Oil & gas drilling
Macy's ($59; M)
1.25
2.1
71
30
57
88
96
Department stores
Norfolk Southern ($103; NSC)
2.16
2.1
13
37
64
62
86
Railroads
Packaging Corp. ($69; PKG)
1.60
2.3
36
43
86
79
94
Paper packaging
UGI ($51; UGI)
1.18
2.3
6
39
84
80
91
Gas utilities
Wells Fargo ($52; WFC)
1.40
2.7
64
36
52
81
91
Diversified banks
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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