Dividend stocks for income investors
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5 more ways to invest for income
Recently, I offered five energy plays for income-oriented investors. Here are five more ways to get income from an increasingly uncertain market.
By Jim Jubak
I launched a new portfolio for income investors on Oct. 14 with my column "5 energy stocks for income investors" because I thought these investors could use whatever help I could offer in a very tough market environment.
Yields weren't very tempting: In fact, if you looked at the 4.5% yield on the 10-year Treasury note, they were downright disappointing. And as if that weren't enough, the Federal Reserve was firmly locked into a series of interest-rate hikes well into 2006 that would knock down the price of any bond an income investor bought.
Two months later, a lot has changed. But not for the better.
The 10-year Treasury note still yields a low 4.5% -- 4.52% on Dec. 1, to be exact. But now there's even less reason to go long since, thanks to the Federal Reserve, short-term rates have moved up so that two-year and five-year Treasury notes yield almost as much as a 10-year issue. The Federal Reserve looks like it will raise rates two or three more times. The Wall Street consensus calls for an end to the rate hikes at 4.5% or 4.75%, up from the current 4%.
Investors face more uncertainty in 2006
But what happens after that is even more uncertain than it was two months ago. Will the Federal Reserve put its rate moves on hold after those increases for the rest of 2006? Or will it be forced to actually reverse course and cut interest rates as the economy weakens in the second half of the year? Traditionally, when the interest-rate curve inverts -- with short-term rates climbing above long-term rates -- as it is near to doing, it signals a potential economic recession. Outgoing Federal Reserve Chairman Alan Greenspan says not this time, but hey, he'll be playing tennis when this pudding gets eaten.
So, right now, income investors are facing low yields, near-term rate hikes that will drive down the price of bonds and other income vehicles and increasing uncertainty about the direction of interest rates for the second half of 2006.
Related news and commentary on MSN Money
Yep, I guess it's time to offer up the rest of my 10-stock portfolio for income investors. For context, here are the first five securities in the portfolio and their current yields (which may have changed since Oct. 14):
- Kinder Morgan Energy Partners (KMP, news, msgs). Current yield: 6.4%.
- Northern Border Partners (NBP, news, msgs). Current yield: 7.6%.
- Magellan Midstream Partners (MMP, news, msgs). Current yield: 6.6%.
- Penn Virginia Resources (PVR, news, msgs). Current yield: 4.7% yield.
- Natural Resource Partners (NRP, news, msgs). Current yield: 5.1% yield.
I also have an important update to that article at the end of this column. I am tracking this 10-stock portfolio called "Dividend stocks for income investors" here. There is also a link on the left side of this column.
How to manage risk and get paid for it
The name of the game right now, in my opinion, is:
Managing the risk that interest rates, inflation or the economy will kick your income portfolio where it hurts, and...
Getting paid decently for the risk you do take.With those principles in mind, I've divided my second five income picks into two parts. The first three picks are stocks that pay a bit more than market rate and where the risks are a bit less than for the fixed income market as a whole. My last two slots are reserved for two ways to keep your money safe -- at the best return -- while you wait for either lower risk or higher yields as 2006 develops.
Three stocks that I think pay you reasonably well for taking limited risks are:
Southern California Edison Preferred (SCEDN, news, msgs). Companies looking to raise cash know that in an uncertain fixed income market, investors are willing to pay a little more for certainty -- which would let the company pay less to raise capital. This senior preferred stock from utility Southern California Edison, a unit of Edison International (EIX, news, msgs), pays a face dividend of 5.35% -- or a current yield of 5.27% when the preferred traded recently at $101.47, above the $100 initial par price -- which is a pretty low interest rate for an issue rated a relatively risky Baa3 by Moody's. But Southern California Edison was able to sell investors on this low yield by offering them a big chunk of interest-rate protection. The initial yield of 5.35% is good until April 2010 and then resets quarterly at 1.45 percentage points higher than whichever is the greatest -- the 3-month London Interbank Offered Rate (LIBOR), the 10-year Treasury note or 30-year Treasury bonds. So after April 2010, you get a yield that's 1.45 percentage points higher than the highest yield, short or long, on the yield curve no matter whether short or long rates are higher. Because these shares are trading at a bit above par, you do face some risk (about 1.5%) to your capital if the company decides to call these shares; they can call them in as early as April 30, 2010. But the company will only call these preferred shares if it can raise new capital at a lower interest rate. I don't know your long-term read on U.S. interest rates, but I see them moving gradually higher over the next decade as the U.S. trade deficit takes its pound of flesh. Of course, I'd like these shares even more if they were trading at par, and they have moved lower recently, so you might be able to solve this whole problem by waiting. (Many brokerages and research data basis use CUSIP numbers, rather than tickers, to identify preferred issues and bonds. To trade or do research on this one, plug the CUSIP number 842400756 into your broker's research or trading engine.)
The Lehman Brothers Holdings Preferred Depositary Shares G Series (LEH-G, news, msgs) is structured so that an investor will do well if short-term rates continue to rise faster than long-term interest rates -- or even if the spread between short- and long-term rates just stays very, very tight. These depositary shares, which each represent 1/100th of a share of the company's floating rate cumulative preferred series G shares, started off paying a minimum 3% dividend. But since that yield floats with short-term interest rates, it has climbed until the shares now yield 4.53%. The interest rate on these shares, payable in monthly dividends, floats so that it stays equal to the one-month LIBOR (currently 4.31125%) plus 0.75%. The initial 3% dividend is now the floor -- even if the LIBOR sinks like a stone, these shares will never pay a dividend of less than 3%. The stock is callable on Feb. 15, 2009, at $25 a share and recently traded at $25.18, a tiny premium to that call price. (While the shares may also use the ticker LEHPRG, use CUSIP #524908639 to research or buy shares.)
Rayonier (RYN, news, msgs) is another way to combat the problem of uncertainty about the direction of interest rates. The stock doesn't give you the same blanket protection as the Southern California Edison preferred does, but unless the economy really tanks, the degree of protection is quite good. Right now, shares of the timber company yield 4.6%. According to Value line, dividends have grown by 11.5% annually over the last five years and Value Line projects annual dividend growth of 18% annually for the next five years. That's a very solid upside on business as usual. If interest rates fall, not only will that dividend look pretty good, but the company's sales of timber and real estate should pick up. If interest rates climb because of inflation, the solid hard assets of the company's timber land should rise in value, too. Only if the economy tanks, taking earnings down no matter what interest rates do, will this stock suffer. I think that's a reasonable risk to take. (The stock has been part of Jubak's Picks since Jan. 7, 2005. I also own shares in my personal portfolio.)
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