Living In A Risky World

8/28/2017


In a perfect world, all large-cap, dividend-paying stocks would be members of the S&P 500 Dividend Aristocrats, companies that have raised their dividends for at least 25 straight years. This group of stocks has outperformed the broad index over the past 10 years.

But as we saw in 2008 and 2009, a combination of economic downturns and corporate mismanagement can bring any streak to an end. To prepare for those trying times, investors of all stripes must consider their ability and willingness to take on risk.

The ability to accept risk indicates whether a portfolio can withstand volatility and potential losses without jeopardizing an investor's financial goals. Risk-taking ability is affected by an investor's time horizon and the size of the portfolio relative to living expenses.

Willingness to take risk reflects whether an investor can psychologically handle the ups and downs of the market. We're talking temperament, not financial status.

Investors run the range of the risk spectrum. With that in mind, we created three portfolios of dividend-paying stocks, segmented according to risk tolerance, in the table below. In building these portfolios, we considered riskiness in multiple ways.

Relative Risk

Our Relative Risk score tracks a stock's volatility using five measures: worst three-month performance in the past five years, performance in up markets, performance in down markets, standard deviation (volatility of monthly returns), and beta (sensitivity to market movement).

Earnings Predictability score

This Quadrix score identifies the volatility of a stock's underlying business, rewarding those that deliver more consistent profits. The score measures the consistency of quarterly per-share-profit growth over the past five years, relative to the average of those quarterly profits. Profits with low variability from quarter to quarter signal a stable business that should withstand downturns better than most. That consistency is crucial for companies trying to grow their dividend each year.

Dividend stability

For dividend stability, we considered each stock's track record for growing its dividend and whether it had lowered its distribution in the past decade. Underlying both characteristics is the payout ratio — the percentage of profits a company devotes to its dividend. Low payout ratios leave management with flexibility to grow the dividend in coming years and a cushion to avoid dividend cuts during downturns.

Below, we review four top dividend stocks with varying levels of risk:

Conservative

Generating a total return of 19% in 2017, Comcast ($41; CMCSa) shares represent one of the brighter spots in the S&P 1500 consumer-discretionary sector (averaging a loss of 1%) and media stocks (averaging a total return of 4%). Growth from its movie studio and theme parks has helped Comcast withstand cord-cutting better than most other pay-TV companies. Hoping to carve out a slice of the expanding mobile-internet market, Comcast also recently launched a wireless service.

Comcast raised its dividend 15% earlier this year, not far off its annualized growth rate of 18% over the past five years. Free cash flow, the fuel for future dividend growth, rose 56% to $1.96 billion last quarter and is up 8% to $8.10 billion for the 12 months ended June. A modest payout ratio of 32% suggests Comcast has the capacity to keep raising its dividend. Comcast, yielding 1.5%, is a Focus List Buy and a Long-Term Buy.

Middle of the road

Although capital expenditures remain Lam Research's ($162; LRCX) top priority for excess cash, management seeks to ramp its dividend and stock buybacks in line with the company's overall growth. Industrywide spending on semiconductor equipment is exceeding Lam's original expectations for 2017, and the company projects another strong year in 2018. Admittedly, the semiconductor-equipment industry is notorious for its volatility. But Lam says it has become less cyclical in recent years due to a growing business providing services, spare parts, and refurbished equipment for its installed base. Installed-base services now account for 25% of revenue.

Lam's quarterly dividend stands at $0.45 per share, up from $0.18 when it was launched in 2014. The company complements its dividend with a steady diet of stock buybacks. Through the end of June, Lam had completed about 70% of the $1 billion stock-repurchase plan announced in November, spending an average of $136 per share. Management expects to complete its current stock-buyback program by November and has also hinted that its next dividend hike could also be announced at that time. Lam is a Focus List Buy and a Long-Term Buy.


Royal Caribbean Cruises' ($121; RCL) raised its 2017 guidance earlier this month, reflecting its strong June quarter, equally robust booking trends, and a shift in consumer behavior that prefers experiences over physical products. Operating cash flow has now increased in seven straight quarters and free cash flow in five consecutive quarters. In the 12 months ended June, Royal Caribbean generated $1.88 billion in free cash flow, versus a negative $658 million in the year-ago period.

The company tends to stash little cash on its balance sheet, currently containing just $130 million. Instead, management has used its cash to pay off long-term debt, down 29% over the past year to $6.48 billion. Royal Caribbean also consistently raises its quarterly dividend, with hikes of 20% or higher in each of the past five years. Management typically announces its dividend increases in September. Another 20% dividend boost would push the stock's yield to 1.9%, versus its current yield of 1.6%. Royal Caribbean is a Buy and a Long-Term Buy.

Aggressive

Based on its last four quarterly dividends, Zions Bancorp ($44; ZION) yields just 0.7%, while S&P 1500 regional banks have an average trailing dividend yield of 2.1%. However, the Federal Reserve has cleared Zions to raise its quarterly dividend $0.04 per share in each of the next four quarters. As a result, Zions' dividend should triple to $0.24 per share by next June, pushing its indicated dividend yield to 2.2%.

In the first half of 2017, the bank grew per-share profits 55% on 11% higher sales. Looking ahead, Zions expects modest growth for loans and customer fees, along with an improving outlook for existing loans made to oil and natural gas companies. Analysts' profit estimates have drifted higher over the past 60 days, with the consensus projecting 30% growth in the September quarter and 23% growth in the December quarter. Zions is a Buy and a Long-Term Buy.

DIVIDEND STOCKS
Below we offer three highly concentrated stock portfolios for income investors with varying risk levels. Each portfolio consists of eight A-rated, divided-paying stocks. The conservative portfolio contains stocks with lower volatility, fairly predictable earnings, and no dividend cuts in the past 10 years. The aggressive portfolio contains riskier stocks that tend to generate less-predictable profits and have either cut their dividend in the past decade or operate with extremely high payout ratios. Recommended stocks are in bold.
Company (Price; Ticker)
Relative
Risk Score
Quadrix
Earnings
Predictability
Score
Indicated
Annual
Dividend
($)
Yield
(%)
5-Year
Annual.
Dividend
Growth
(%)
Payout
Ratio
(%)
Consecutive
Years Of
Dividend
Growth
Cut
Dividend
In Past
Decade?
Quadrix
Overall
Score
Conservative
Amgen ($169; AMGN)
Below
average
97
4.60
2.7
27
37
6
No
94
Comcast ($41; CMCSa)
Low
89
0.63
1.5
18
32
9
No
93
Lowe's ($73; LOW)
Below
average
97
1.64
2.2
20
40
32
No
85
Snap-on ($142; SNA)
Low
100
2.84
2.0
15
29
7
No
90
Texas Instruments
($81; TXN)
Low
98
2.00
2.5
24
50
13
No
91
Union Pacific ($105; UNP)
Below
average
87
2.42
2.3
17
44
10
No
72
UnitedHealth Group
($194; UNH)
Low
93
3.00
1.5
30
33
8
No
89
Visa ($103; V)
Low
95
0.27
0.3
26
8
8
No
81
Middle of the Road
Bank of New York Mellon
($53; BK)
Average
89
0.96
1.8
8
29
7
Yes
85
CBS ($65; CBS)
Above
average
98
0.72
1.1
12
17
6
Yes
75
Intel ($35; INTC)
Average
32
1.09
3.1
5
37
3
No
97
J.P. Morgan Chase
($92; JPM)
Above
average
82
2.24
2.4
13
34
7
Yes
85
Lam Research ($162; LRCX)
Average
83
1.80
1.1
NA
18
2
No
100
Magna International
($47; MGA)
Above
average
95
1.10
2.3
8
20
8
Yes
100
Royal Caribbean Cruises
($121; RCL)
Average
84
1.92
1.6
29
27
5
Yes
98
Charles Schwab ($40; SCHW)
Above
average
97
0.32
0.8
5
22
2
Yes
71
Aggressive
American Tower ($143; AMT)
NA
50
2.56
1.8
32
98
6
No
73
Bank of America ($24; BAC)
Above
average
62
0.48
2.0
50
29
4
Yes
94
Citigroup ($67; C)
Above
average
35
1.28
1.9
74
26
3
Yes
67
Comerica ($70; CMA)
Above
average
55
1.20
1.7
18
29
8
Yes
97
General Motors ($35; GM)
Above
average
2
1.52
4.3
NA
23
2
Yes
90
Manulife Financial
($20; MFC)
Above
average
53
0.65
3.3
3
NA
4
Yes
93
Morgan Stanley ($46; MS)
Above
average
62
1.00
2.2
32
29
4
Yes
83
Zions Bancorp ($44; ZION)
Above
average
56
0.48
1.1
52
19
5
Yes
96
Note: Quadrix scores are percentile ranks, with 100 the best. Ā  NA Not available.

 


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