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5 reasons dividends count right now
If your portfolio is beaten up -- and whose isn't? -- it's time return to good old dividends. Here's how to start your search.
By Jim Jubak
Forget about Cisco Systems (CSCO, news, msgs) earnings and when the battered technology sector will bounce back. Forget about a rally in financials on hopes of a Federal Reserve interest rate cut. Even forget about bottom-fishing like Warren Buffett.
Instead lets concentrate on the first step that most investors should take to begin rebuilding a battered portfolio -- stocking up on stocks with hefty dividends.
Why do I think dividends -- dull, old-fashioned dividends -- are so important right now?
Ive got five reasons. Each one is reasonably convincing, and as a package, the logic is hard to resist.- First, the historical record shows that dividends are critical in reducing the time it takes the stock market -- and hence the equity portion of a portfolio -- to recover after a vicious and extended bear. According to data from Ibbotson Associates, it took the Standard & Poors 500 stock index ($INX) seven-and-a-half years to climb back to its pre-crash price after the 1973-'74 bear-market period -- if you just consider capital appreciation. But if you include dividends in the calculation, then it took battered portfolios just three-and-a-half years to recover the value that they had lost in the bear. In a period of stagnant stock prices and frequent failed rallies -- the kind of period that often follows a prolonged bear market -- the reliability of dividend payments takes on an added importance in building positive returns for a portfolio.
- Second, a conscious policy of buying high-dividend stocks now may be the only way to make up for the historically low level of dividends in the current stock market. Coming out of the bear market at the end of 1974, the stocks in the S&P 500 yielded 5.25%. The index currently yields just 1.82%. Thats way up from the 1.12% yield on the index in the first quarter of 2000, just before the bear bit down, but its still way below the juicy yield that helped speed recovery after the last bear market. The only way to make up for this yield gap in the average stock is to go looking for the above-average yields offered by specific stocks in some sectors.
- Third, adding high-yielding stocks to your retirement portfolio is one way to make the recovery plan I outlined in my last column, Rethink your retirement plan, less daunting. I know from my e-mail that the idea of trying to save an extra $10,000 or more a year in order to rebuild a retirement portfolio seems impossible to many readers. But remember that my calculations for that strategy were based on expectations of an 8% annual return. Any investor who can find reasonably safe yields above 8% can trade some of that expected return for some planned savings. (Reasonably safe is the key concept -- adding high-yielding stocks that crash and wipe out part of your principal doesnt help.)
- Fourth, with the baby boom retirement bulge still ahead of us -- even if somewhat delayed by the need of many boomers to work longer than they hoped -- the current shortage of high-yielding investments is likely to get even worse. Every retiring boomer will be looking for that safe 6% and the demand for those kinds of yields will, markets working like they do, result in climbing prices for those instruments and falling yields. It is not too soon to anticipate that situation by buying some of the high yields that have resulted from the Crash of 2002, even if you are still years and years away from retirement. With a return to market stability, those yields will shrink. And even if youre years away from retirement, the return of stability and better credit ratings for corporations is likely to produce solid -- or better -- gains from capital appreciation in higher yielding and currently riskier investments.
- And fifth, concentrating on high-yielding stocks in the current stock market keeps an investor focused on buying value. Think of this strategy as a version of the annual Dogs of the Dow play -- but instead of buying the five (or 10) highest-yielding stocks in the Dow Jones Industrial Average ($INDU) on the first trading day of January, my strategy extends to the entire stock market. But in both cases an investor is looking to buy solid companies that are temporarily depressed in the hope of a turnaround -- and with the knowledge that the high-dividend yield makes waiting for the turnaround that much easier. (See our Stock Screener for a Dogs of the Dow screen and a description of the strategy.)
Consider the risks
So what do you do?
Well, actually lets start with what you dont do -- you dont chase yield without regard to the risk in the underlying company.
For example, lets take a look at Northern Border Partners (NBP, news, msgs), a master limited partnership, paying a dividend of better than 9%. Besides the high dividend, this one is worth checking out because the company is in the natural gas pipeline business. Energy stocks are depressed right now, which is one reason why Northern is paying such a high yield, but natural gas pipelines are an attractive near-local monopoly business that pay annuity-type returns. Pipeline companies get paid on the volume of gas they ship -- and not on the price of that gas -- so theyre protected from the biggest swings in gas prices but remain sensitive to changes in economic activity. If I bought Northern, Id be betting on an economic recovery sometime in the not-too-distant future, but Id also know that Id get paid 9% while I wait. And gas pipelines have another attractive quality: Its hard to build new ones. So pipeline companies often have regional route monopolies. I didnt think of that angle myself -- its part of the logic behind Warren Buffetts recent acquisitions in the pipeline industry.
But buying Northern Border Partners isnt without risk. Riskless stocks dont pay 9%, after all. For example, Northern Border Partners has a trigger on $475 million of senior debt that could force almost immediate repayment of the sum in case of further downgrades in the companys credit rating. And then theres the Enron (ENRNQ, news, msgs) taint. You see, the general partners in the master partnership, the ones who run the show, are units of Enron and Williams Companies (WMB, news, msgs).
So to make a decision on buying Northern Border Partners you have to weigh that 9% yield against these risks. The company has said that it believes it would have no problem raising the money to cover the $475-million debt repurchase if a downgrade triggered that event -- and it has also said that it doesnt see a downgrade on the horizon. And we know that Enron has put its general partnership interest up for sale as part of that companys bankruptcy. Many Wall Street analysts believe that a change in ownership of the general partner wont have any effect on Northern Border Partners.
Your call. I dont have enough confidence that I can get a solid read on these risks to recommend the stock despite the yield. But this is a good example of the kinds of trade-offs youll have to consider as you go hunting for high-yielding stocks.
Don't shoot for the moon
Now, how do you go about that search?
As my discussion of Northern Border Partners indicates, you cant depend on screening alone to make these picks. A screen for high-yielding stocks is a good place to start, but from there youll have to take apart promising candidates one at a time.
Remember that for dividends to do your portfolio some good, you dont have to shoot for the moon. Any dividend that pushes the yield on your portfolio above the 1.82% current yield on the S&P 500 will help speed your portfolios recovery from this bear market. So Id build a screen that looked for yields above 3.6%; thats twice the level of the yield on the S&P 500.
Then Id look for two other characteristics in the group that screen turned up. First, Id look for companies that are showing signs of improving their balance sheets. The reason that many high-yield stocks are high yield is that investors are worried about the credit worthiness of the company. As an investor in one of these situations youd like to see signs that the company is on the road to eliminating those worries. A better balance sheet and less worry will lead to upgrades and a climb in the stock price (along with a reduction in yield) to reflect the improved balance sheet.
Second, Id look for companies that are improving the fundamentals of their business. Were talking stocks here, remember, and, as an investor, that means you should be looking for capital gains, eventually, as well as yield. Nothing wrong with buying a stock just for yield when that yield is above what you can earn on a treasury bond, but theres no reason to ignore the possibility of capital appreciation as we eventually pull out of this bear market.
Which, of course, raises the question of when you should think about implementing a high-yield dividend strategy as part of rebuilding a portfolio? There is no point in taking unnecessary capital losses just to get a 4% yield.
In my opinion were still in the bear market. The current rally is real I think. (See the update below.) It is, however, a rally in a bear market, and I dont think that were headed straight up from the recent July lows without at least one drop that tests the convictions of investors who have held fast so far.
ConAgra Foods (CAG, news, msgs)
So, while at the moment I currently find the 3.8% yield on ConAgra Foods (CAG, news, msgs) attractive and I think the stock meets my requirements for a company that is improving its balanced sheet and the fundamentals of its business, I won't squeeze the trigger on this one until I have a better idea of where the market is headed.
As I said, theres no point in taking a loss just to get a 4% yield.
New developments on past columns
3 risk scenarios in an ugly market
The recent rally strikes a number of technical analysts as real, if not enough to put an end to the bear market. Dan Sullivan, the editor of The Chartist newsletter, for example, believes that there is a good chance that recent moves set the stage for a retrenchment of the ground lost since the highs of March. That would take the Dow back to 9,650, about 1,000 points above recent levels. It would also, Sullivan notes, take the Dow right to its 200-day moving average, a level likely to prove tough for the market to crack. The near-term question, in Sullivans opinion, is whether this rally has enough momentum to carry the Dow above its July 31 high at 8,736. We certainly came close to that mark on Thursday, and a strong move above that would raise the odds of seeing 9,650. But then again, weve seen this market run out of momentum before.
Look for growth in late bloomers
The recovery at Lamar Advertising (LAMR, news, msgs) continues. On Aug. 7, the company posted break-even earnings that matched Wall Street expectations on revenues of $203 million. That was solid follow-through on the companys May 7 announcement raising revenue guidance for the quarter to $201 million from Wall Street estimates of $195 million. After the earnings announcement, Credit Suisse First Boston raised its revenue estimates for 2002 and said that it continues to see a turnaround in the outdoor advertising market. Goldman Sachs noted that the company has plenty of excess capacity that is slowly coming into use and that should drive earnings higher in future quarters. As of Aug. 9, Im keeping Lamar Advertising in Jubaks Picks but to reflect the slower pace of the economic recovery, Im stretching out my target price to March 2003 and lowering it to $41 from the prior $49.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index.
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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