Dividend payers set the pace


Shares of dividend-paying companies have held up well in 2008. The median dividend payer in the S&P 1500 Index is down 0.6% and including dividends has returned 0.5%. In contrast, stocks with no dividends have posted a median decline in price (and total return) of 4.7%. Overall, 51% of dividend payers have price gains this year, versus 40% of nonpayers.

Whether dividend payers have staying power is open for debate. But at least four factors suggest income stocks could continue to lead the market.

>> While dividend growth has slowed, many companies continue to raise their payouts. In the March quarter, S&P 500 Index companies paid out nearly $62 billion in dividends, up more than 5% from the year-earlier period. Shares supported by strong dividend growth tend to outperform, and Wall Street typically reacts favorably to dividend hikes.

>> Choppy equity markets, coupled with an uncertain economic outlook, have stock investors seeking lower-risk names that provide steady income. Dividend payers in the S&P 1500 have a median beta of 1.0, versus 1.4 for nonpayers. A gauge of sensitivity related to market movements, beta compares a stock’s performance to that of the S&P 500 Index, which by definition has a beta of 1.0. Low-beta stocks are generally less volatile relative to the overall market.

>> As the graying of America continues, more investors are looking for ways to bolster income in a low-interest-rate environment. Traditional income investments offer paltry rates: The average five-year certificate of deposit yields just 3.6%, while the 10-year Treasury note pays around 3.8%. Given that backdrop, common stocks that pay dividends offer an appealing source of income, with the added potential for capital appreciation.

>> Dividend-paying stocks offer an attractive yet potentially short-lived tax shelter. Prior to mid-2003, dividends were taxed as ordinary income, at rates as high as 35%. Most dividends are now taxable at a 15% federal rate (or a 5% rate for taxpayers in the two lowest tax brackets). The lower tax rates apply to qualified dividends received before Jan. 1, 2011.

A portfolio consisting of equal-dollar positions in all 30 stocks would yield about 2.2% and provide dividends every month. All of the stocks have Quadrix Overall scores above 63, with the portfolio average Overall score at a solid 83. Not all of the stocks are rated Buy or Long-Term Buy, but all have some appeal for an income-oriented portfolio. Four of the stocks are discussed below.

With just $9 million in debt and $2.58 billion in cash and short-tern investments, Accenture ($38; NYSE: ACN) has the flexibility to continue repurchasing shares, raising its dividend, and acquiring new businesses. Accenture expects free cash flow of more than $2 billion for fiscal 2008 ending August.

Accenture has a short but impressive record of dividend growth. The company began paying a dividend in 2005, then boosted it by 17% in 2006 and 20% in 2007. Accenture is aggressively repurchasing shares as well, with $549 million spent in the February quarter. At the end of February, Accenture was authorized to repurchase another $3.6 billion in shares, or about 16% of its market capitalization.

Accenture is also using its cash to make niche acquisitions, with three deals announced this month. Most recently, the consultant agreed to purchase ATAN, a privately held Brazilian technology-services firm. Other deals announced this month were the purchases of Origin Digital, which offers broadband and video services, and AddVal Technology, which provides logistics systems for freight management and airline cargo. Terms of the deals were not announced.

Despite projected per-share-earnings growth of 32% in fiscal 2008 and 8% in 2009, Accenture trades at just 14 times estimated year-ahead earnings, well below the average of 18 for professional-services firms and the company’s five-year average of nearly 24. Accenture is a Focus List Buy and a Long-Term Buy.

Over the last 10 years, General Dynamics’ ($94; NYSE: GD) operating cash flow increased at an annualized rate of 18%, while dividends rose at a 10% clip. At the end of 2007, the defense contractor had more cash ($2.89 billion) than debt ($2.79 billion). The company spent $519 million on share buybacks in the March quarter, and additional buybacks and dividend hikes are likely.

The new Gulfstream G650 (marketed by the company as the fastest, widest, and longest-range business jet) should help sustain General Dynamics’ earnings power. Already, about 500 prospective buyers have plunked down $500,000 apiece and signed letters of intent indicating their desire to purchase one of the jets when they begin rolling out of the factory in 2012. The Gulfstream unit expects to deliver 83 G650s by 2014.

While the G650 represents a long-term revenue-growth catalyst, the end of uncertainty over General Dynamics new CEO could give the stock a short-term boost. Investors had been skittish about the end of the 11-year run of the current CEO, Nick Chabraja. Current board member Jay Johnson, CEO of Dominion Virginia Power and former Navy admiral, will take over in June 2009. Johnson, who spent four years as Chief of Naval Operations, has the background to manage the company’s defense operations. General Dynamics is a Buy and a Long-Term Buy.

IBM ($125; NYSE: IBM) ended the March quarter with more than $12 billion in cash and short-term investments. The computer giant’s diverse group of businesses combined to generate more than $17 billion in operating cash flow over the last 12 months. Much of that money is already earmarked for a massive share-repurchase program. IBM has spent $94 billion in share buybacks since 1995, and in February the company authorized another $15 billion in repurchases, with up to $12 billion expected this year.

The slowdown in the U.S. economy has not affected IBM as much as many believed it would. IBM posted an unexpected 6% increase in U.S. revenue in the March quarter. Foreign operations delivered much stronger growth. More than 60% of IBM’s sales come from overseas, and the huge services unit may collect as much as 75% of its revenue from outside the U.S. IBM’s international presence allows the company to participate in the global infrastructure-spending boom.

Consensus estimates project 20% per-share-earnings growth in 2008 and 12% growth in 2009. IBM, trading at a reasonable 15 times the 2008 consensus profit estimate, is a Focus List Buy and a Long-Term Buy.

PepsiCo ($67; NYSE: PEP), with an annualized dividend-growth rate of 11% over the last 10 years, now yields 2.5% after a 13% increase in May. PepsiCo has the resources to continue returning cash to shareholders. In 2008, PepsiCo expects operating cash flow of $7.6 billion, up nearly 10%, of which it plans to spend $4.3 billion on share repurchases.

To achieve its cash-flow goal, PepsiCo must deal with the substantial commodity-price inflation expected this year. Citing the rising cost of grain, cooking oil, and energy, PepsiCo in April estimated that commodity costs will rise between 9% and 10% this year, up from an earlier estimate of 6%. So far, PepsiCo has been able to lock in the price of some commodities, reduce some of its other costs, and raise prices enough to cover inflation. The strategy continues to work, as sales volume grew 4% in the March quarter.

Overseas operations are generating robust growth. PepsiCo International must often alter its product mix or supply chain quickly to deal with fluctuations in currencies. That flexibility should help the company’s international units cope with rising commodity costs. PepsiCo is a Buy and a Long-Term Buy.

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