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The 10 best income stocks
Times are tough for income investors, but these stocks promise reliable and rising income even as interest rates rise.
By Jim Jubak
"The 10 best income stocks," the headline for this piece trumpets. And I certainly intend to deliver on that promise. Before this column is over, you will find a list of what I believe are the 10 best income stocks to buy now.
But a minor piece of business first: What exactly characterizes the best income stocks now?
Lets take that concept apart piece by piece to see what were looking for.
What I mean by best
Best income means most income but it also means reliable and rising income. At a minimum, any best income stock should yield more than the 2.8% offered by the two-year Treasury note now. An investor willing to hold that Treasury note to maturity is safe from any likely increase in interest rates because the note will return the investors capital at maturity. Any stock, even the safest, is riskier than that and should pay more.
But best income also has to be reliable. The company must be able to pay that dividend this year and next year and the next, just like a bond does. For example, Net Perceptions (NETP, news, msgs) carries a dividend yield of 192% based on its Sept. 3, 2003, payout of $1.50 a share in dividends and a recent share price of just 83 cents. But nobody should count on Net Perceptions paying out any dividends ever again. The company is in the midst of a bitter liquidation battle and is appealing a Nasdaq order to delist the stock. The $1.50 payout last September was, as the company said at the time, a return of investors capital and not a dividend paid from profits.
And since this isnt a bond, my definition of best income also includes rising income. An investor who continues to hold stock in a company that increases its dividend over time will receive an increasing cash flow from that original purchase each year. That way, investors have the magic of dividend compounding working in their favor.
Best income stock means, at worst, a stock that doesnt fall in value and, at best, appreciates in price. Nobody should expect that even the best stock will never fall, of course. What counts is that the price is stable or better over some reasonable period, say two years to match the two-year maturity of our benchmark Treasury note. The best income stock will be stable enough so that the investor willing to hold for two years has a very good chance of seeing a return of the original invested capital.
Best income stock now means the stock in question is well suited to the current and reasonably foreseeable future. At the moment, that means rising but not runaway inflation, and rising but not runaway interest rates. This argues in favor of companies that own tangible things that will go up in value with inflation. Id put land, oil and gas reserves, copper, nickel and iron deposits, energy infrastructure, timber and the like in this category. It argues against companies that are dependent on borrowing to increase their revenues and earnings and that use leverage to increase their earnings and cash flow. Many limited partnerships in the energy sector and many real estate investment trusts fall into this category.
This last part of the definition means that todays list will be very different from the list of 5 stocks to retire on -- and count on that I produced in my March 5 column. That list -- AmeriGas Partners (APU, news, msgs), Enbridge Energy Partners (EEP, news, msgs), Fording Canadian Coal Trust (FDG, news, msgs), Northern Border Partners (NBP, news, msgs) and Texas Pacific Land Trust (TPL, news, msgs) -- was dominated by master limited partnerships that depend on borrowing to buy new assets for most of their growth. As a group, those five havent done badly since I recommended them: An equal-dollar investment in all five would have returned 6.6% from March 5 through July 30. (Thats above my 6% worst-case goal set in that article, by the way.)
Related news and commentary on MSN Money
My top 10
But rising interest rates will dampen price appreciation in these stocks and lower total return. So I think its time to switch from this group (except for Texas Pacific Land Trust, which makes the current list, as well) to a more growth-oriented group of income stocks. You dont have to do it overnight. With the first reading on growth in second-quarter gross domestic product coming in at 3% Friday, below the consensus forecast of 3.7%, interest rates arent about to zoom higher. But they will be higher in 2005 than they are now, and income investors ought to reposition all or part of their portfolios accordingly.
OK, now to my list (in alphabetical order) of the 10 best income stocks now. (I highlighted three of these, FPL Group (FPL, news, msgs), Rayonier (RYN, news, msgs) and UGI (UGI, news, msgs), in my Wednesday appearance on CNBC TVs "Morning Call.") - BP (BP, news, msgs): It makes this list in preference to Exxon Mobil (XOM, news, msgs) because of its higher dividend yield (3% to 2.4%) and in preference to other oil majors because, thanks to its Russian joint venture, the company is just about assured of reaching its goal of increasing output by 5% a year for the next five years. The company raised its dividend to 42.6 cents per ADR from 40.5 cents when it reported second-quarter results July 27.
- Citigroup (C, news, msgs): A bank? Whats it doing here? Well, how often to you get to buy one of the worlds great banking franchises with a 3.6% yield? Everyone knows that bank stocks will get hammered when interest rates rise, which is why Citigroups stock is down 8.5% in the last six months. But if youre willing to hold for two years, as I outlined above, youre just about guaranteed the safe return of your capital. The bargain is likely to get even better later this year and into 2005, so you might want to wait on this one before you buy.
- FPL Group (FPL, news, msgs): In its July 23 second-quarter earnings report, the company said it was highly confident that 2004 earnings per share would fall between $5.05 and $5.15 and confident that earnings momentum will continue into 2005. But that confidence seems a lot more convincing to me because the board at this Florida utility holding company voted to increase the dividend by 10% to 68 cents a share from 62 cents for shareholders of record as of Aug. 27. The stock now yields 4.1%.
- Plum Creek Timber (PCL, news, msgs): The company upped its quarterly dividend to 36 cents from 35 cents a share on July 27. This is a sign that the timber and forest-products company is succeeding in its drive to realize more of the value of its 8.1 million acres of timberlands by selling selected acreage into the real estate market. The stock now yields 4.6%.
- Progress Energy (PGN, news, msgs): The company supplies electricity to fast-growing markets in Florida and the Carolinas, so it has the same kind of demographic trends filling its sails as Floridas FPL. But the stock carries a higher dividend than FPL, 5.3% to FPLs 4.1%, because Progress Energy is still very much a work in progress. For example, the company has a large railcar division that doesnt fit in with the rest of the business and that has underperformed. The company plans to sell it, but until that deal goes through, the railcar business is a drag on the stock price.
- Rayonier (RYN, news, msgs): Rayoniers two core businesses are turning trees into wood products and performance fibers, and managing and selling its timberland. The stock yields 5.1%, extraordinarily high for the timber industry thanks to its structure as a REIT after a January conversion. Rayonier has increased its dividend by about 5.5% annually over the last five years. On July 28, Rayonier reported second-quarter revenue growth of almost 14% from the year-earlier period.
- San Juan Basin Royalty Trust (SJT, news, msgs): This company doesnt do much of anything -- except pay dividends. As a royalty trust, it collects royalties on oil and gas pumped from its lands in New Mexico. Burlington Resources (BR, news, msgs) does the actual pumping. The trusts monthly payments vary with the price of natural gas, so owning this stock is a pure play on rising natural gas prices. The stock carries a 7.1% dividend yield, but that comes with some interesting wrinkles. Trust owners get a tax credit due to the kind of gas pumped from the companys land. Payouts arent taxed until the shares are sold because of the way that energy-depletion accounting works. Investors should also note that San Juan is a self-liquidating company: It has only a limited amount of gas, and once thats gone, so are the distributions. Estimates are that the gas should last another 15 to 20 years.
- Texas Pacific Land Trust (TPL, news, msgs): This trust works just about the same way that the San Juan Basin Royalty Trust does, except that instead of collecting and distributing royalties from oil and gas, Texas Pacific collects the proceeds from selling some of the 1 million acres of land it owns in western Texas each year and then uses that cash to buy back shares. (Texas Pacific also collects oil and gas royalties on almost 400,000 acres of Texas land and receives other cash flow from the fees ranchers pay to graze cattle on its land.) Since very little of the companys cash goes to paying a dividend (the yield is just 0.7%), investors get their income in the form of a steady appreciation of the companys share price as it buys back more shares, decreasing shares outstanding.
- TransCanada (TRP, news, msgs) owns 24,000 miles of pipeline that move the majority of western Canadas natural gas to markets in Canada and the United States. This makes the company a long-term play on the growth of Canadian gas production and its increasing importance to the U.S. market. The recent acquisition of the Gas Transmission Northwest Corp., expected to be final by the fourth quarter, will extend TransCanadas system from British Columbia into California. The stock yields 4.3%.
- UGI Corp. (UGI, news, msgs): It's a holding company that distributes propane through AmeriGas Partners, one of the master limited partnerships in my March 5 income portfolio, and conducts its utility business through subsidiary UGI Utilities. The company just increased its dividend effective with the July payment. This 9.6% hike to an annual $1.25 a share marks the 17th consecutive year that UGI has raised its dividend. The company has paid a dividend on its common stock for 120 years. The stock now yields 3.9%.
The goal in each of these 10 income stocks is total return, a measure that combines price appreciation and dividend payouts. So, for example, UGI, which yields 3.9%, has posted an average annual total return of 13.5% over the last 10 years.
Past performance is, as they say, no guarantee of future results, but with interest rates and inflation both threatening to move higher over the next five years, growth income stocks like these have the best chance of taking income investors to their goals.
New developments on past columns
3 growth stocks with room to grow
Everything went wrong for Bunge (BG, news, msgs) in the second quarter -- and still the company blasted through Wall Street earnings estimates and raised its projections for 2004 as a whole. Turmoil in the Chinese soybean industry stopped Bunge from exporting soybeans from Brazil to China. Lower U.S. soybean supplies pushed prices up. Avian influenza in Asia cut demand. And still on July 29 Bunge reported earnings of $1 a share, up from 71 cents in the same quarter of 2003, and way above the 77 cents a share consensus Wall Street estimate. The company also raised its 2004 earnings forecast to between $3.12 and $3.29 a share. The Wall Street consensus had called for $3.07 a share for all of 2004. So what went right? Higher volumes and higher prices -- 18% higher -- in the companys fertilizer business. Astute use of hedges that enabled Bunge to control raw-material costs and higher soy-bean volumes that pushed gross profit margins to 7.5% for the quarter, up from 5.1% in the second quarter of 2003. And a lower tax rate in Brazil, thanks to declines in the value of the Brazilian currency. Looking forward, the projections for a bumper U.S. soybean crop and lower soybean prices led Bunge to increase its guidance for 2004. As of Aug. 3, Im leaving my target price for Bunge at $44 a share by September 2004.
Its time to buy oil stocks, not sell them
Could ChevronTexaco (CVX, news, msgs) be getting its act together? For the second quarter, reported on July 30, the company announced earnings of $3.04 a share after excluding gains for asset sales and tax benefits. That trounced the Wall Street consensus estimate of $2.62, according to Zacks Investment Research. ChevronTexaco earned $1.61 a share in the second quarter of 2003. With oil prices hitting record highs this year, its not hard to figure out where the gains came from: Sales in the quarter climbed by 31%. But despite the results, the work isnt done yet at ChevronTexaco. Production, as expected, fell 4% year over year. The company seems to be getting ready to fix that production problem with an acquisition. Cash and marketable securities climbed to $9 billion at the end of the quarter from $4 billion at the end of 2003. The company did distribute some cash, however: ChevronTexaco announced a 10% increase in its dividend and a 2-for-1 stock split. Record date for both the dividend and the split is Aug. 19. As of Aug. 3, Im keeping my target price of $99 (pre-split) a share by December 2004.
My hell-in-a-hand-basket portfolio
Royal Dutch/Shell Group has agreed to pay $150 million in penalties to U.S. and British regulators to settle charges that the company, owned by Shell Transport and Trading (SC, news, msgs) and Royal Dutch Petroleum (RD, news, msgs), overstated its oil and natural-gas reserves. The sum includes a $120 million payment to the U.S. Securities & Exchange Commission to settle the agencys finding that the oil company violated antifraud, reporting and record-keeping provisions of U.S. securities laws and SEC rules. This doesnt end the investigation into the inventory overstatements since the SEC can still bring civil charges against individuals and the U.S. Justice Department is conducting its own investigation. But the settlement does put one big problem behind the oil company.
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: BP, Rayonier and Shell Transport and Trading. He does not own short positions in any stock mentioned in this column.
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