Income, Quality Rarely Mix

4/6/2015


Stock investors looking for income have it pretty tough.

Sure, you can get high yields — if you stick to a few industries or settle for stocks with questionable fundamentals. Or you can focus on the fundamentally strong, only to learn that few of these stocks offer generous yields.

The table below illustrates the difficulty in finding balance. The two sectors with the highest average yield (utilities and telecom) rank no higher than ninth out of the 10 sectors in three-year dividend growth and fifth out of 10 in Quadrix Overall score. In contrast, the two sectors with the highest Overall scores (consumer discretionary and industrials) rank no higher than seventh in yield. These numbers provide yet another reason why investors — even those seeking income — should judge each stock on its own merits. Don't just collect utilities because they pay high yields or ignore industrials because they don't.

TOUGH TO FIND INCOME, FUNDAMENTALS TOGETHER
The two S&P 1500 Index sectors with the highest average yields tend to have lower dividend growth and Quadrix Overall scores, while the top Overall scorers don't offer much yield. Only one sector — financials — ranks among the top half based on yield, dividend growth, and Overall score.
-- Dividend Yield --
3-Year Annualized
- Dividend Growth -
-- Quadrix Scores --
S&P 1500 Sector
(Number Of Companies)
Average
(%)
Rank
Average
(%)
Rank
Average
Rank
Cons. Discretionary (237)
1.2
8
11
7
64
1
Consumer Staples (70)
1.8
5
9
8
50
9
Energy (100)
2.2
4
11
6
56
6
Financials (297)
2.7
3
18
2
62
3
Health Care (157)
0.6
10
13
3
56
7
Industrials (219)
1.3
7
12
5
62
2
Technology (244)
0.8
9
18
1
59
4
Materials (101)
1.8
6
12
4
54
8
Telecom (15)
3.6
1
(3)
10
47
10
Utilities (60)
3.5
2
5
9
56
5
S&P 1500 (1,500)
1.6
13
59
Note: Quadrix scores are percentile ranks, with 100 the best.

Only the financial sector ranks in the top half in all three statistics, and you shouldn't sacrifice diversification to fill your portfolio with financials.

So, what is an income investor to do?

Narrow your focus and seek the best of both worlds. We broke the S&P 1500 into 62 industry groups (ignoring the four groups with fewer than four stocks), then sifted them according to the following criteria:

• Average yields of at least 1%. Forty-three groups made the cut.

• Average three-year annualized dividend growth of at least 10%. That criteria knocked out 19 of the 43 high-yield groups, leaving 24.

• Average Quadrix Overall scores of at least 60. Only 13 of the previous 24 groups made the cut.

The 13 groups that satisfied all three screens seem like fine places to start looking for high-quality stocks with decent yields and the wherewithal to keep the payout growing over time. Check out the table below for a list of recommended stocks in those groups. Four are reviewed below:

Cable giant Comcast ($57; CMCSa) initiated its dividend in 2008. But what the dividend lacks in longevity, it makes up in growth. In the wake of an 11% hike in February, the payout has risen at an annualized rate of 23% over the last seven years and 35% over the last three.

Despite talk of cord-cutting, Comcast has enjoyed excellent operating momentum. In 2014, Comcast grew operating cash flow 7% and per-share profits 19%. Credit the growth to a combination of slower-than-expected erosion of video subscribers (a net loss of 194,000 last year), and aggressive gains in voice (470,000) and internet (1.28 million) customers.

Comcast has absorbed plenty of bad news in recent weeks. Federal regulators have once again delayed their review of the company's proposed acquisition of Time Warner Cable ($152; TWC); Apple ($124; AAPL) plans to launch a cheap TV bundle; and the Obama administration seeks to step up regulation of the internet. However, the profit consensus for this year has fallen to 1% growth, which seems overly pessimistic. Comcast is a Buy and a Long-Term Buy.


Drugstore chain and pharmacy-benefit manager CVS Health ($102; CVS) has boosted its dividend at an annualized rate of 27% over the last 10 years. Fewer than 4% of S&P 1500 stocks can top that growth. Despite the more than tenfold gain in the payout for the decade, CVS' estimated dividend of $1.40 per share accounts for less than one-third of trailing 12-month earnings.

Both of the company's core businesses tend to be consistent and fairly insensitive to the economy. The consensus projects sales growth of nearly 8% and per-share-profit growth of roughly 14% this year and next year, with potential upside to those targets. Managed-care giant UnitedHealth ($117; UNH), which also operates a PBM, agreed late last month to buy Catamaran ($59; CTRX). The deal should boost UnitedHealth's negotiating power with drugmakers, which is bad news for a pharmaceutical industry increasingly dependent on high-priced specialty drugs. CVS, the second-largest PBM in the country, stands to benefit from any loss of influence for drugmakers. CVS, yielding 1.4%, is a Buy and a Long-Term Buy.


Like other big U.S. banks, J.P. Morgan Chase ($60; JPM) is trying to make up for lost time. Its dividend has increased at an annualized rate of 17% over the last three years, but just 2% over the last decade. That disparity reflects an 87% dividend cut in 2009. Since early 2011, J.P. Morgan has raised its quarterly payout four times, including a boost to a record-high $0.40 per share last year. While the company hasn't made the hike official, it plans to boost the payment 10% to $0.44 per share starting in July. The dividend payout ratio stands at 29% of earnings, and J.P. Morgan hopes to reach 50% if regulators allow.

J.P. Morgan Chase shares trade at 11 times trailing earnings, 41% below the bank group average and 12% below the average for the company's subindustry, diversified banks. The consensus projects per-share-profit growth of 9% this year and 12% next year. Given the company's estimate that profits would rise by $2.9 billion ($0.50 per share) for each percentage-point rise in interest rates, estimates could prove conservative. J.P. Morgan, yielding 2.7%, is a Long-Term Buy.


Automobile-components stocks average Quadrix Overall scores of 77, fourth-best among the 62 industry groups. But even within that high-scoring collection of stocks, Lear ($112; LEA) stands out. Its 99 Overall score is tops in the group, while its annualized dividend growth of 21% over the last three years and 10% over the last 10 are among the highest. Lear's dividend yield of 0.9% isn't especially impressive, but the estimated year-ahead payout equals just 12% of trailing 12-month earnings, leaving plenty of flexibility for continued hikes.

Over the last year, Lear grew sales 9%, operating cash flow 13%, and per-share profits 67%. Despite that superior growth — not to mention the high Overall score and robust dividend expansion — Lear trades at 12 times projected 2015 earnings, 29% below the industry average. The stock's Value score of 87 is well above the industry average of 68. Analysts project Lear's per-share profits will rise 20% to $2.20 in the March quarter. Lear is a Focus List Buy and a Long-Term Buy.

QUALITY STOCKS IN INDUSTRIES WITH INCOME APPEAL
We recommend 11 dividend-paying stocks from among the 13 groups that satisfied our three-part screen.
Dividend Growth
---------- P/E Ratio ----------
Company (Price; Ticker)
Div.
($)
Yield
(%)
3
Year
(%)
10
Year
(%)
Payout
Ratio
(%)
Trailing
12 Mos.
Vs. 5-
Yr. Avg.
Versus
Industry
Average
Quadrix
Overall
Score
Sector
Industry
Ameriprise
($130; AMP)
2.32
1.8
27
18
27
15
1.16
0.86
98
Financials
Capital mkts.
Comcast ($57; CMCSa)
1.10
1.9
35
NM
38
19
1.12
1.02
91
Discretion.
Media
CVS Health ($102; CVS)
1.40
1.4
29
27
31
23
1.38
1.05
76
Staples
Food/drug ret.
J.P. Morgan ($60; JPM)
1.60
2.7
17
2
29
11
1.09
0.67
75
Financials
Banks
Kroger ($77; KR)
0.74
1.0
17
NM
21
22
1.62
1.01
92
Staples
Food/drug ret.
Lear ($112; LEA)
1.00
0.9
21
10
12
14
1.38
0.78
99
Discretion.
Auto compon.
Lincoln National
($57; LNC)
0.80
1.4
36
(5)
13
9
1.01
0.69
99
Financials
Insurance
Magna Int'l
($53; MGA)
e
0.88
1.7
17
9
19
11
0.80
0.64
93
Discretion.
Auto compon.
Travelers ($107; TRV)
2.20
2.1
10
10
21
10
0.93
0.74
98
Financials
Insurance
U.S. Bancorp
($43; USB)
1.02
2.3
27
1
33
14
1.02
0.87
83
Financials
Banks
Wells Fargo
($54; WFC)
1.50
2.8
19
5
37
13
1.15
0.83
75
Financials
Banks
Note: Quadrix scores are percentile ranks, with 100 the best.     NM Not meaningful because company didn't pay dividends 10 years ago.    e Estimated.

 


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