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Jubak's Journal
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| | Jubak's Journal
10 income stocks for squeezed investors
Anyone depending on investments to pay the mortgage has got to be worried as interest-rate increases loom. Your best bet: stocks that pay growing dividends.
By Jim Jubak
The squeeze on income investors just keeps on getting worse. And 2004 is not likely to bring anything except a further tightening of the vise.
Stocks, not bonds, are the best bet in this tough environment. And in this column Ill give you the names of my 10 stock picks for income investors.
The vise thats squeezing income investors right now works like this: Interest rates are extremely low. You can find a money market account paying 2%, but the national average is just 0.61%. The three-month Treasury bill pays just 0.88%. The national average yield on a 12-month CD is just 1.17%.
Of course, you can up the yield and your income by buying a CD or bond with a longer maturity. If youre willing to lock up your money for five years, you can find a CD that pays as much as 4.3%. (The national average is about 3.1%.) Yield on a 10-year Treasury bond fell to 4.2% on Dec. 17. (To find CD rates, click here.)
Why interest rates probably will rise
But thats not a lot of yield to get in return for locking up your money for a substantial period of time, especially when the next move in interest rates will be upward.
All the data suggest that move wont come until late in 2004 or even early in 2005. Inflation, as measured by the Consumer Price Index, was a negative 0.2% in November for an annual rate of 1.8%. The core inflation rate, which excludes the volatile food and energy sectors, dropped 0.1% in the month. The 1.1% annual rate for core inflation is at a 40-year low. That makes it extremely unlikely that the U.S. Federal Reserve will raise rates in the first half of 2004.
But the data also argue that interest rates will be higher at the end of 2004 than they are today. The economic recovery is strong enough that its starting to persuade CEOs to spend money on new inventory and even on new plants and equipment. Thats good news, of course, to people out of work and for stocks that have climbed on expectations of an increase in corporate earnings. But more economic activity also pushes interest rates higher most of the time because much of the money to finance that expansion will come from borrowing.
The continued decline of the dollar against the euro and yen also puts upward pressure on interest rates. Overseas investors are fleeing the dollar and dollar-denominated investments, such as Treasury bonds, because they believe that the huge U.S. current-account deficit and the huge federal budget deficit will push the dollar lower still. In the third quarter, we added another $135 billion to what we owe our trading partners, for example. Under the circumstances, its not hard to see why foreign investors dont want to own more of a currency thats likely to lose more value in the future. Just about the only thing that, in the short term, might change their attitudes toward the dollar would be an increase in U.S. interest rates.
The squeeze on income investors
All this adds up to a big squeeze on income investors. With interest rates so low right now, putting new money to work at 1% or less or rolling a maturing, higher-yielding investment over into a new investment at 1% isnt especially attractive to anyone. To investors who have to live on income from their investments, that kind of short-term yield is a disaster.
But going out on the yield curve to get a higher interest rate by locking up your money for a longer period of time exposes you to the risk that interest rates will start to climb sometime in 2004. If your choice of an income investment is a bond, a climb in interest rates would drive down the price of your bond. If you protect yourself against that kind of price depreciation by buying a CD, you lock up your money at current low rates in what could well be a period of rising interest rates.
A good argument for income investors to buy stocks
Thats why I prefer stocks to bonds for income investors right now for two reasons:
- Unlike bonds, stocks are likely to go up in price if the economic recovery keeps on chugging. Higher growth translates into higher interest rates, which drive down bond prices. But higher growth produces higher corporate earnings, which lead to higher stock prices.
- Unlike bonds, stocks pay out higher dividends over time, investors hope. If a growing economy and growing earnings lift company profits, some of that increase will get passed along to investors as higher dividends. The dollar payout from a bond is fixed at the time of the bonds issue.
Here are 10 stocks that I think will give investors better-than-average income and growth over the next 12 to 18 months.
| 10 great income-and-growth stocks | | Company | Industry | Dec. 22, 2003 price | Current div. yield | 5-year div. growth * | | Avery Dennison (AVY, news, msgs) | Paper and paper products | $54.31 | 2.7% | 10.6% | | Citigroup (C, news, msgs) | Banking | 48.50 | 2.9 | 24.6 | | ConAgra (CAG, news, msgs) | Food | 26.15 | 4.0 | 9.3 | | Eli Lilly (LLY, news, msgs) | Pharmaceuticals | 72.20 | 2.0 | 9.1 | | FPL Group (FPL, news, msgs) | Electric utilities | 64.61 | 3.8 | 3.5 | | Genuine Parts (GPC, news, msgs) | Wholesale auto parts | 33.19 | 3.6 | 3.5 | | Mack-Cali Realty (CLI, news, msgs) | Office REITs | 40.48 | 6.3 | 4.3 | | ProLogis (PLD, news, msgs) | Industrial REITS | 31.80 | 4.6 | 3.1 | | Sara Lee (SLE, news, msgs) | Food | 21.01 | 3.6 | 5.9 | | Shell Transport & Trading (SC, news, msgs) | Major oil & gas | 44.03 | 3.7 | 16.1 |
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*Annualized
To come up with this list, I started by building a screen using our Deluxe Screener. Here are my criteria:- I looked for stocks that paid better than the current 1.8% yield on the two-year Treasury and that had increased dividends by better than 3% annually over the last five years.
- To make sure that I wasnt looking at a company that was about to run out of cash to pay its dividend, I required a payout ratio of less than 85%. (The payout ratio is the 12-month dividend payout divided by the 12-month earnings per share.)
- To minimize my risk and maximize the potential price appreciation, I looked for stocks with a low or very low risk expectation rating from our StockScouter rating system and a high or very high return expectation. (To see how StockScouter rates Avery, for example, click here.)
- And finally, to make sure that these stocks were liquid enough so that Id be able to get out if I needed to, I required a market capitalization of $1 billion or better.
That resulted in a list of 159 stocks. Click here to see the list generated by this screen.
From there, I sifted the list looking for stocks with a potential to climb in price if the economy kept growing. Also, I wanted stocks that werent likely to take a big hit if interest rates started to climb or if investors started to worry about higher rates.
Growth counts in the selection
I also tilted my final list toward stocks with a history of substantial increases in their dividend payout and companies that I thought were likely to see an increase in cash flow that would enable them to up their payout.
On the list youll find just one utility, FPL Group (FPL, news, msgs). Most utilities are still digging themselves out from under the financial rubble of the collapse of the industrys building spree in the 1990s. Most arent in a position to raise dividends since theyre fighting for survival.
Youll see two real estate investment trusts, ProLogis (PLD, news, msgs) and Mack-Cali (CLI, news, msgs). I picked these of all the real estate investment trusts that showed up on the original list because they concentrate in two areas, warehouses and suburban office space, that are likely to do best in an economic recovery.
I kept a few stocks on the list, such as Avery Dennison (AVY, news, msgs), Eli Lilly (LLY, news, msgs) and Citigroup (C, news, msgs) despite their relatively low dividend yields because theyve been so aggressive in hiking dividend payouts during the last five years. All three companies are likely to have the cash to keep that up in the future.
And I included a number of stocks with current dividend yields that approached or bettered the current 4.2% yield on the 10-year Treasury note because I know some income investors have a pressing need to maximize income now.
In short, something for every portfolio, I hope, and a way for every income investor to breathe a little more easily while the current income squeeze lasts.
Changes to Jubaks Picks
Sell Inco
Inco (N, news, msgs) has rallied to hit my September 2004 target price of $37 a share slightly ahead of schedule in December 2003. That puts the stock in that uncomfortable zone where my calculations show that the shares are fundamentally fully valued but momentum remains strong enough to drive the stock higher, perhaps another 20%. Im uncomfortable following the momentum play here with the stock market itself about to come off its end of the year strength and enter a more uncertain period. Investors who are better at momentum strategies than I am should be able to make some more money on Inco, but Im going to follow my fundamental bent and sell the shares here. I have a 33% gain in Inco since I added the shares to Jubaks Picks on Sept. 23 at $28.21 a share.
New developments on past columns
T. Rowe Price, Stryker make Clean Stocks list
On Dec. 18, Paychex (PAYX, news, msgs) announced earnings per share of 21 cents for the November second quarter of the companys 2004 fiscal year. Net income climbed 8% from the year earlier quarter (earnings per share increased by just a penny) and revenue grew by 16.4%. The earnings numbers matched Wall Street consensus but revenue figures were slightly above expectations. Revenue grew by about 10% once you take out the effect of two recent major acquisitions. The stock got hammered on the results, however, when Paychex said that it was reducing its projections for net income growth for the full fiscal year to the high single digits from an earlier 10%. (The stock was down 7.6% on Friday.) Although the company didnt explain why it was lowering projections, Wall Street analysts speculate that its taking longer to cut costs while Paychex integrates acquisitions Interpay and Advantage. The reduced guidance works out to a drop of 2 cents or so in fiscal 2004 earnings per share.
Nothing in this changes my belief that Paychex is a double-barreled play on (1) the economic recovery finally beginning to add jobs and (2) outsourcing of back-office jobs such as payroll as companies in the United States and Europe continue to look for ways to cut costs. Id use this sell-off to add to positions in the stock. As of Dec. 23, Im keeping my target price of $43 a share but stretching out the deadline to June 2004 from December 2003. (Full disclosure: I will be adding shares of Paychex to my personal portfolio three days after this column is posted.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Paychex. He does not own short positions in any stock mentioned in this column.
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