Brett Arends's ROI: Looking for extra income? These blue-chip stocks may crush bonds with a 5% payout

This post was originally published on this site

If you’re a widow, orphan or any other conservative income investor, consider adding utilities, telecoms companies and other consumer goods stocks to your portfolio this quarter.

You should be looking overseas for the best low-risk payouts, including to European, Japanese and other foreign stocks, while slashing your U.S. exposure dramatically.

And you should be thinking defense, because lots of stocks which look like they are going to pay a big fat dividend are going to give investors a big flat slap in the face instead, by cutting their payouts, or canceling them altogether. ‎

So say the ‘quality income’ strategists at investment bank SG Securities in their latest report.

Dividend forecasts world-wide were slashed by a hefty 13% last quarter, they write. But the cuts for the stocks in their quality income bask were cut by barely a third of that.

Income investing in stocks is becoming more important, thanks to the collapse in interest rates. Once upon a time grandma could put her money in certificates of deposit, Treasury bonds, municipal bonds, and investment grade corporate bonds, and earn a good 6% or 7% a year.

No risk. No volatility. No worries.

No more.

Today 10 year Treasury Notes sport about the lowest interest rates in history at just 0.6%. A one year CD pays little more than 1%, if you’re lucky. So-called ‘inflation protected securities,’ special bonds issued by the federal government, now promise to earn you less than inflation for the next 30 years. ‎

So it makes sense for income investors to look to stocks. ‎

But income investing is a dangerous game, because stocks are very different from bonds. Prices are volatile, and payouts can be slashed as well as raised. If a company goes into chapter 11 the bondholders typically get back at least something, because they have first claim on the assets. Stockholders rarely get a bean.

Investing in stocks with the highest dividend yields, for example, is generally a bad idea. Companies that sport the highest apparent yields are generally in distress. Either they are paying the dividends by borrowing the money, a shell game that rarely ends happily, or they’re about to cut the dividends.

That’s the case right now with a lot of oil and commodity stocks, for example, and a ton of European banks. ‎Money manager Mark Urquhart at Edinburgh-based Baillie Gifford reports that by some estimates, world-wide dividend income from stocks could be cut this year by as much as 25% to 40%.

Data compiled by Ken French, the legendary finance professor at Dartmouth College, finds that the best long term returns have come by far from stocks in the second or third quintile down from the highest yields. In other words, those with dividend yields that are well above average, but not at the top. The gaps historically have been huge, too. Since the 1920s, stocks in the second quintile — the second tier down out of five — by dividend yield have beaten the top quintile by an average of more than one full percentage point a year, and stocks in the middle of the pack by nearly two full points. (To be sure, as noted recently, the past is a very imperfect guide to the future.)

SG top number crunchers Andrew Lapthorne and George Oikonomu say that an even smarter strategy has been to analyze company earnings and balance sheet risk as well, to make sure that you’re buying the dividend stocks that are in the best shape to weather turbulence.

It may not have seemed that important a few years ago. But, oh boy, does it look important now.

So where do you look? Their latest “quality income” basket is massively invested in telecoms stocks (21% of the portfolio), consumer goods (also 21%), utilities (19%) and health care 11%). The ‘consumer goods’ stocks, incidentally, include Big Tobacco and some stocks such as Unilever.

Holdings in financial stocks: Zero.

Holdings in oil and gas: Nearly zero. ‎

And it’s very international. They’re only 13% invested in U.S. stocks, compared with around 45% in Asia and Australasia, and 40% in Europe. Japan, at 19%, has the biggest country weighting.

This may not be a surprise. Many Japanese stocks have balance sheets so cast iron they have net cash, not net debt, and many have at last been raising their miserly dividends. ‎ (Your correspondent has some of his retirement portfolio in the iShares Japanese Value ETF EWJV, +0.85% for precisely this reason.) ‎

Big U.S. names on the SG list include Coca-Cola KO, +0.74%, Kellogg K, +0.28%, Pfizer PFE, +4.14%, Verizon VZ, -0.11%, Philip Morris International PM, +0.79%, Altria MO, +0.29%, and Gilead Sciences GILD, +1.36%.

Forecast dividend yield this year for that basket of seven stocks: A hefty 5.1%, says FactSet.

It’s tough for fund investors to access this sort of thing just through mutual funds or exchange-traded funds. For a variety of reasons, including compliance and marketing, your general ‘income’ or ‘value’ fund isn’t going to take big bets on individual companies or sectors like this. ‎

Bottom line: If you’re looking for income, it’s far from crazy to turn to stocks. But be careful what you’re buying. You need to look beyond the dividend yield, and understand the business. Otherwise you may end up getting some nasty surprises. ‎

Add Comment