Our Top 7 Stocks For Income

3/8/2010


When we promise our top income stocks in a headline, we know we’re going to disappoint some readers with picks yielding 2.2% to 3.2%. But we also know the only way to endure in the investment-newsletter business is to call it like we see it, and our extensive research with dividend stocks suggests investors attach far too much importance to high dividend yields.

Don’t get us wrong. A dividend initiation or increase is a powerful signal, and a record of steady dividend growth is a keen indicator of quality. Portfolios limited to dividend-paying stocks tend to be less volatile than those filled with nonpayers. But stocks with above-average dividend yields have not delivered superior returns. In fact, those with very high yields tend to bring extra risk without extra reward.

In a back-test of S&P 1500 stocks to 1994, the top yielders did not perform significantly worse than stocks with low and middling yields. But the variety of stocks and sectors represented among the highest yielders pales in comparison to the broader universe, so an investor limited to such names has less ability to add value by seeking the best stocks.

The top 5% of S&P 1500 stocks based on dividend yield have delivered an average 12-month total return of 10.4% since 1994 — in line with the returns of all dividend-paying stocks. But among the top 5% of dividend yielders, the top one-fifth based on Quadrix® Overall score returned an average of 10.9% — considerably less than Quadrix standouts not limited to such high-yielders.

With this lesson in mind, the stocks listed in the table below and reviewed in the following paragraphs represent our favorite income stocks because they rank among our favorites of all stocks — and also have attractive yields and strong dividend-growth prospects.

A lingering concern regarding Abbott Laboratories ($55; ABT) is the decelerating sales growth of Humira, a blockbuster arthritis treatment that accounted for 18% of 2009 revenue. But the company faces less generic pressure than other drug-makers. Humira, for instance, is sheltered from generic competition until December 2016. Last month’s $6.4 billion acquisition of Solvay’s pharmaceutical business added promising new vaccines and increased exposure to emerging markets.

Abbott also produces medical and diagnostic devices (29% of 2009 sales) and nutritional products (17%). A strong balance sheet and rising free cash flow should support more acquisitions — and higher dividends.

Abbott has not missed a quarterly dividend since 1924 and has raised its dividend for 38 consecutive years. The most recent hike was announced in February, a 10% bump to $0.44 per share. The stock offers a plump dividend yield of 3.2%, but the moderate payout ratio of 47% leaves plenty of room for more dividend growth. Wall Street anticipates 14% earnings growth in 2010 and 13% in 2011. Abbott, with an Overall score of 90, is being added to the Buy List. The stock is also a Long-Term Buy.


While many players in financial services cut dividends in 2009, Aflac ($50; AFL) boosted its quarterly payout for a 27th straight year. Aflac said it will consider another hike later this year but first wants to assess global financial markets and its own capital position. Aflac says it will also consider reviving stock repurchases.

The stock, yielding 2.2%, earns steady Quality and Financial Strength scores that rank among the top 15% of stocks covered in our research universe. Over the past year, Aflac absorbed investment losses with its cash generation. The insurer also issued $400 million of debt in December to solidify its capital base.

The stock trades at 10 times projected trailing earnings, 34% below the three-year average P/E ratio of nearly 16. Should Aflac reach even the most conservative analyst earnings estimate of $5.28 per share for 2010, and the P/E returns to the three-year average, the stock would reach $80. With 2010 earnings estimates rising over the past month, Aflac is a Focus List Buy and a Long-Term Buy.


Without interruption or reduction, General Mills ($73; GIS) has paid a dividend for the past 111 years. The company declared two dividend hikes in 2009, including a 4% increase announced in December. The stock yields 2.7% — higher than about 81% of U.S.-traded stocks.

Although sales growth is likely to slow over the next five years, expansion opportunities in Brazil, India, and China support management’s goal of $18 billion in sales in fiscal 2015. For fiscal 2010 ending May, sales are expected to total $14.8 billion. General Mills expects per-share earnings of $4.52 to $4.57 for the year. Wall Street takes a more bullish view, with the $4.60 consensus estimate implying 16% growth.

Operating profit margins, up sharply over the past three quarters, are poised to expand further on productivity initiatives expected to save General Mills about $1 billion over the next three years. General Mills is a Focus List Buy and a Long-Term Buy.


Some of Travelers’ ($53; TRV) first products insured passengers against train and steamboat accidents. Today, Travelers’ coverage extends to workers’ compensation, surety bonds, and personal lines that insure against damages caused by weather.

Unusually mild weather bolstered Travelers’ profits in 2009 but makes for a challenging comparison this year. Wall Street expects 8% lower per-share earnings in 2010, though estimates are rising. The long-term profit outlook remains intact, and consensus estimates project 8% annualized growth over the next five years.

The company’s dividend has increased every year since 2005. The $1.32 per share annual payout equates to a yield of 2.5% and represents just 23% of expected 2010 earnings. Travelers’ solid balance sheet and rising free cash flow bode well for continued dividend growth.

Relative to trailing earnings, sales, cash flow, and book value, the stock trades at a discount to five-year norms. Already a Buy and a Long-Term Buy, Travelers is being added to the Focus List.

OUR 7 FAVORITE INCOME STOCKS

About 80% of U.S.-traded stocks have dividend yields below 2.4%, so the seven below rank among the higher-yielding stocks available. More important, all seven rank among the best of all U.S. stocks on total-return potential.

Enterprise ratio, a highly effective metric with dividend-paying stocks, equals enterprise value (the sum of shareholders equity and debt, less cash) divided by earnings before interest, taxes, depreciation, and amortization.

5-Year
Annualized
Dividend
Growth
(%)
Long-Term
Estimated
Profit
Growth
(%)
— Enterprise Ratio —
————— Quadrix Scores * —————
Company (Price; Ticker)
Div.
($)
Yield
(%)
Payout
Ratio
(%)
EV/
EBITDA
Quadrix
Rank
Momen-
tum
Value
Quality
Overall
Abbott Laboratories
($55; ABT)
1.76
3.2
47
8.8
11.6
10.0
43
67
78
89
90
Aflac ($50; AFL)
1.12
2.2
23
24.1
13.4
NA
NA
76
89
86
98
Comcast ($17; CMCSa)
0.38
2.2
30
NM
12.5
5.8
82
73
96
88
96
General Mills ($73; GIS)
1.96
2.7
44
9.0
9.7
8.8
53
73
65
88
85
Johnson & Johnson
($63; JNJ)
1.96
3.1
42
12.0
7.0
9.0
52
64
76
80
81
Raytheon ($57; RTN)
1.24
2.2
25
8.6
8.7
6.1
79
71
90
90
94
Travelers ($53; TRV)
1.32
2.5
23
3.1
7.7
4.1
93
96
93
79
98
* Percentile ranks, with 100 the best.     NM Not Meaningful because company paid no dividend five years ago.    
NA Not Available.

 


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