Fat Yields? Fat Chance

2/13/2017


With friendly banter and a magic wand, magicians use misdirection to distract audiences from uncovering the secret behind their tricks. Investors can similarly get sidetracked by stocks promising massive yields that may be nothing more than an illusion.

Most data services present forecasted (also called indicated) yield, which extrapolates the current quarterly or semiannual dividend over the next 12 months. However, there can be a big gap between a stock's forecasted yield and its realized yield, or what it actually pays out.

Stocks with forecasted yields exceeding 10% ultimately delivered average realized yields of roughly 3% from 1996 to 2015, according to CNBC, which used data provided by Mellon Capital and FactSet. This shortfall underscores a chief problem for high-yielding stocks: They are the most vulnerable to dividend cuts. These companies are often saddled with poor underlying fundamentals and high payout ratios, leaving little flexibility when they face a cash crunch. Conversely, stocks with forecasted yields lower than 4% tended to deliver the promised yield.

The CNBC study is especially troubling, given the rising number of companies cutting their dividends. Last year, 19 companies in the S&P 500 Index lowered their dividends, the most since 2009, according to Standard & Poor's. An additional two companies suspended their distributions.

Sometimes lost amid income investors' quest for yield is the potential for share-price appreciation. S&P 1500 Index stocks with dividend yields above 2% have recently generated unusually strong 12-month returns relative to the rest of the market, as shown in the table below. But higher-yielding stocks have historically lagged stocks with lower yields and nonpayers.

MIXED TRACK RECORD FOR HIGH YIELDS

Based on rolling 12-month returns, non-dividend-paying stocks in the S&P 1500 Index have outperformed the average stock over the past decade and since 1994. But stocks yielding 2% to 4%, as well as stocks yielding above 4%, have fared better in the past one-year period.

Stocks without yields tend to have more volatile returns, and this volatility can skew return comparisons based on simple averages. However, the conclusions from the table below would be similar using geometric returns, though the relative returns of non-dividend stocks would look slightly worse for all periods.

------------------------- Average 12-Month Return -------------------------
All S&P
1500 Stocks
(%)
----------------------- Dividend Yield -----------------------
Selection Date
0%
(%)
Up To 2%
(%)
2% To 4%
(%)
Above 4%
(%)
Past 1 year (12 periods)
7.6
2.8
7.8
11.6
11.1
Past 5 years (60 periods)
13.4
12.7
13.4
14.4
13.2
Past 10 years (120 periods
10.6
11.3
9.5
10.1
9.9
Since 1994 (253 periods)
13.0
14.0
11.9
12.2
12.5

Five of our top dividend picks are reviewed below:

Great Plains Energy ($27; GXP), an electric utility based in Missouri, joins our Top 15 Utilities portfolio this week. The company offers solid operating momentum, with profit margins and revenue both climbing in each of the past four quarters. Great Plains has also raised its dividend in each of the past six years, including a 5% hike announced in November. At 15 times trailing earnings, Great Plains is one of only two S&P 1500 electric utilities to trade more than 10% below its own five-year median and its peer-group median.

The stock's low valuation may partly reflect concerns about a pending takeover. In May, Great Plains agreed to acquire Westar Energy ($54; WR), the largest electric utility in Kansas, in a mostly cash deal valued at $8.6 billion. Great Plains will also assume Westar's $3.6 billion of debt. Some doubt whether the deal will go through, but the combined company would supply electricity to more than 1.5 million customers in Kansas and Missouri. Following the deal, management expects per-share profits to grow at annual rate of 6% to 8% through 2020. While we like the deal for its profit-growth potential, it wouldn't surprise us to see the shares bounce if the merger falls through — which suggests possible upside for shareholders either way.

Great Plains will likely offer an update on the deal, expected to close this spring, when it announces December-quarter results on Feb. 24. Wall Street analysts expect per-share profits of $0.11, down 27%, on revenue of $580 million, up 3%.


J.P. Morgan Chase ($86; JPM) shares yield 2.2%, well above the 1.8% average for S&P 1500 diversified banks. J.P. Morgan has raised its dividend more than 7% in each of the past six years. The bank also consistently repurchases its own shares, shrinking its stock count by 10% since March 2011. The number of outstanding shares has declined sequentially in 11 straight quarters.

CEO Jamie Dimon has insisted he will only buy back stock if valuations remain attractive. In December, Dimon went one step further, saying he would pay a special dividend in lieu of share repurchases if the stock reaches a certain level. That price level is anyone's guess, but the bank's shares remain within a whisker of their all-time high, hit in January. The shares have returned 57% including dividends over the past 12 months In Quadrix, J.P. Morgan earns a solid Value score of 77, slightly below its 12-month average of 82. J.P. Morgan is a Long-Term Buy.


Ingersoll-Rand's ($80; IR) dividend, paid in each of the past 106 years, has withstood downturns and depressions. Still, the financial meltdown took a toll, as Ingersoll cut its dividend in 2009 and again in 2010 to conserve cash as losses mounted.

Ingersoll has steadily rebuilt its dividend since 2010. Over the past five years, the company has grown its dividend at annualized rate of 26%; just 11% of stocks in our research universe have raised distributions at a faster pace. As a result, its quarterly dividend stands at $0.40 per share — more than twice what the company paid before the Great Recession. Even after a pair of hikes in 2016, Ingersoll's dividend accounts for a fairly conservative 38% of earnings.

Strong operating momentum and an improving balance sheet should help support future dividend growth. Cash from operations surged 76% in 2016, while free cash flow more than tripled to $969 million. Ingersoll is a Long-Term Buy.


Master limited partnership Star Gas Partners ($10; SGU) could be the poster child for what happens when a company's unwieldy dividend becomes unsustainable. The stock routinely yielded more than 10% until October 2004, when, faced with a cash crunch, management was forced to cancel the dividend. Not only did income investors lose out on a big quarterly payout, they also got hammered by the stock plunging 80% on the day the suspension was announced. Investors who reviewed the stock's payout ratio would have noticed something amiss. In the five years leading up to its dividend suspension, Star Gas paid a quarterly dividend of $0.575 per share — even though its annual profits never topped $0.13 per share.

The company's dividend is in far better shape today. Since reinstating the payout in 2009, Star Gas has raised its distribution every year, including an 8% bump in 2016. It devotes 61% of earnings to its dividend, slightly below the average payout ratio of 63% for S&P 1500 utilities. Equally important, profit growth remains healthy. For the December quarter, Star Gas said earnings per share surged 47% to $0.28 excluding special items but missed the consensus. Revenue jumped 20%. Star Gas, yielding 4.0%, is a member of our Top 15 Utilities portfolio.


Vectren ($55; VVC) or its predecessor companies have raised their dividend in 57 straight years. Each of its past two dividend hikes was 5%, the most recent one announced in November. That's notable, considering annual dividend increases from 2005 to 2014 ranged between 1% and 3%. Management says it now targets annual dividend growth of 5% to 7% over the long term.

Vectren, a diversified utility, supplies gas and electricity to portions of Indiana and Ohio. Vectren will disclose its December-quarter results on Feb. 23. The consensus anticipates quarterly earnings per share of $0.81, up 2%. Vectren expects annual profits to climb at a 5% to 7% annual clip going forward. Vectren is a member of our Top 15 Utilities portfolio.

TOP PLAYS FOR DIVIDEND YIELD AND GROWTH
We screened for recommended stocks and members of our Top 15 Utilities portfolio that yield at least 2.0% and have grown their dividends for a minimum of five consecutive years.
Company (Price; Ticker)
Dividend
($)
Indicated
Yield
(%)
5-Year
Average
Yield
(%)
5-Year
Annualized
Dividend
Growth
(%)
Payout
Ratio
(%)
Quadrix
Overall
Score
Stocks on our recommended lists
Amgen ($168; AMGN)
4.60
2.7
2.0
48
39
85
CVS Health ($77; CVS)
2.00
2.6
1.5
29
35
82
Ingersoll-Rand ($80; IR)
1.60
2.0
1.7
26
39
78
J.P. Morgan Chase
($86; JPM)
1.92
2.2
2.7
18
32
92
Top 15 Utilities
Allete ($66; ALE)
2.14
3.3
3.9
3
70
43
Atmos Energy
($75; ATO)
1.80
2.4
3.1
5
53
51
Great Plains Energy
($27; GXP)
1.10
4.0
3.8
5
59
71
Portland General
($44; POR)
1.28
2.9
3.4
9
62
39
Public Service Enterpr.
($44; PEG)
1.64
3.8
4.0
3
57
58
Scana ($70; SCG)
2.30
3.3
3.9
3
58
65
Star Gas Partners ($10; SGU)
0.41
4.0
5.7
5
61
82
UGI ($47; UGI)
0.95
2.0
2.7
6
41
60
Vectren ($55; VVC)
1.68
3.0
3.8
3
67
70
WGL Holdings
($83; WGL)
1.95
2.3
3.5
4
59
53
Note: Quadrix scores are percentile ranks, with 100 the best.

 


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com