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Dividend Stocks: The Income Investment of Choice
Investors seeking income face both volatility and high prices. One answer: Nonenergy stocks with hefty, and growing, payouts.
Master limited partnerships (MLPs) have plunged in recent months, high-yield bonds are going up and down like yo-yos, and some real estate investment trusts (REITs) now look pricey. Whats an income investor to do?
Going for blue-chip dividend stocks is one answer, analysts say. Junk bonds, Treasuries, investment-grade corporate bonds, cash all those have value, says Josh Peters, director of equity income strategy for Morningstar in Chicago. But given the risk of junk bonds and the low yields of the last three investments, he says, high-quality dividend stocks can best play most of the pistons of the income engine.
Analysts also see opportunities in high-yield municipal bonds, private corporate debt and preferred stocks. Also, some MLPs and REITs remain a good bet, they say.
As for blue-chip dividend stocks, they present an attractive combination of safety and yield in a time of heightened volatility for many asset classes. Investors can earn a yield of about 4 percent on some of these stocks, with expected dividend increases of 4 to 6 percent a year and, likely, capital gains as well, Peters says.
Martin Fridson, chief investment officer at money management firm Lehmann Livian Fridson Advisors in New York, says his firm is often able to find companies that raise their dividend 10 percent or more annually and have a payout ratio of only 20 percent. We dont look so much at what a stocks yield is now, but at what the yield will be on cost going out two to three years, he says.
When it comes to specific stocks, Peterss favorites include Charlotte, North Carolinas Duke Energy Corp. and Compass Minerals International, based in Overland Park, Kansas. Duke, the countrys largest utility, sports a yield of 4.25 percent. About 90 percent of Dukes earnings come from its regulated businesses, and for several years the company has successfully lobbied for higher customer rates from regulators, says Andrew Bischof, an equity analyst at Morningstar. Compass Minerals, a producer of salt and fertilizer, yields 3.82 percent. It holds an enviable portfolio of cost-advantaged assets, says Morningstar senior equity analyst Jeffrey Stafford.
Meanwhile, as high-yield corporate bonds suffered bouts of extreme weakness over the past ten months, high-yield municipal bonds fared better. The S&P Municipal Bond High Yield exPuerto Rico index has returned 6.96 percent over the past year, compared with 3.42 percent for the S&P U.S. Issued High Yield Corporate Bond index.
High-yield munis strength stems from the improving fiscal condition of municipalities, as their tax revenues rise owing to steady economic growth, says Karim Ahamed, senior investment adviser at HPM Partners in Chicago. So, municipalities are better equipped to service their debt, and they have very little exposure to energy, unlike many companies that have issued junk bonds. Theres a tax benefit too, of course, as muni bond interest income is exempt from federal taxes.
This is one of the safer ways to get high yield, Ahamed says. His customers invest in Nuveen High Yield Municipal Bond I, with a yield of 5.7 percent, and the more conservative Nuveen Short Duration High Yield Municipal Bond I, with a yield of 3.5 percent.
On the private debt front, with banks pulling back from providing loans to small and midsize companies, there are attractive opportunities to lend to them, Ahamed says. Big midmarket lenders like GE Capital, which is being sold off in pieces by parent General Electric Co., have pulled back or gone out of business, he points out. The sector is starved for credit. It needs capital for growth, says Ahamed.
HPM has placed its clients money in Golub Capital BDC, which invests in the debt of midmarket companies sponsored by private equity firms. Thats advantageous because investors have the comfort of knowing that the private equity firms will ride herd over their companies to make sure they perform well, Ahamed says.
As for preferred stocks, you can get yields of more than 7 percent on blue-chip issues, such as those of Bank of America Corp. and Citigroup. Banks and other financial companies account for most of the issues. Banks have strengthened markedly, thanks to stricter regulation following the 200809 financial crisis. Preferreds may not be as exciting as stocks, but they work as a quasi-fixed-income strategy, Fridson says. And because preferred issues arent big enough to attract institutional investors, prices can be volatile, creating opportunities for value, he adds.
When it comes to MLPs, not all are doomed to failure, analysts say. Some midstream partnerships, which include transport, storage and marketing, that havent accumulated too much debt represent good bets, because they are less vulnerable to falling oil and gas prices than are producers, analysts reason. Peters recommends Tulsa, Oklahomas Magellan Midstream Partners, as well as Enterprise Products Partners and Spectra Energy Partners, both based in Houston.
REITs have a geographic advantage over some other income investments, says Bill Stone, chief investment strategist for PNC Asset Management Group in Philadelphia. With worries abounding over global growth, REITs are almost 100 percent domestic, he says. Youre tapping into domestic growth.
Whereas some REIT valuations may be stretched, Fridson and Peters like the health care sector, which should benefit from increased spending by aging baby boomers. Peterss favorites are Chicago-based Ventas and Toledo, Ohiobased Welltower, both health care REITs. Fridson touts cell tower REITs, which should continue to reap the rewards of explosive growth in data usage on cell phones.
So theres no need to let low interest rates drive you away from income investments: Opportunities abound.