By Serkan Unal
Safety of equity investments becomes especially important during market downturns. Given the increased uncertainty in the markets, triggered by the reinstatement of higher capital gains taxes as of 2013 and the impending fiscal cliff that threatens to sink the economy into a recession, "safe" stocks are gaining in appeal. They are particularly popular because they have high long-term price stability and high financial strength, implying solid corporate balance sheets. These stocks generally fall less than the market as a whole when stock prices drop.
Value Line, an independent investment research and analysis company, ranks stocks according to its proprietary Safety Ranking methodology, granting the highest status to those stocks that are least risky investments relative to Value Line's universe of some 1,700 stocks, which accounts for 90% of market capitalization of all U.S.-based stocks.
For prudent investors, we have selected five stocks with Value Line's highest and above-average Safety ranks that pay above-average dividend yields, compared with the indicated dividend yield of the S&P 500, and have a high potential for capital appreciation. These five stocks have market capitalization in the range between $2.75 billion and $20 billion and dividend yields between 2.7% and 4.2%.
St. Jude Medical Inc. (STJ) is a maker of cardiovascular and implantable neurostimulation medical devices. The company pays a dividend yield of 2.7% on a payout ratio of 39%. Its competitor Medtronic Inc. (MDT) is yielding 2.4%, while rival Boston Scientific Corporation (BSX) does not pay regular dividends. St. Jude Medical Inc.'s has demonstrated robust growth over the past five years, with EPS expanding, on average, 11.4% annually. Analysts expect that the medical device maker's new products and expansion in emerging markets will drive long-term growth for the company. EPS growth is expected to average 10.5% per year for the next five years. Dividends, which increased 9.5% in the first quarter from 2011, are up for another boost early next year. The company, which boasts a solid balance sheet and healthy free cash flow, is undertaking measures to lower operating expenses and to hedge against the upcoming MedTech tax from 2013. The stock has a high free cash flow yield of nearly 7%. It has an ROE of 16.5%. St. Jude's stock has a forward P/E of 9.8, and is priced at a discount to the medical equipment industry (with a forward P/E of 21.6) and competitor Medtronic (11.3). The stock is popular with Adage Capital (check out its top picks) and John Roger's Ariel Investments (review its top holdings).
The Washington Post Company (WPO) is not the usual dividend pick among income investors, but this owner of Kaplan Inc. education firm, its cash cow, and the Washington Post newspaper has raised dividends in nine out of 10 past years, or cumulatively by 69% since 2003. The company has announced it will pay its 2013 dividends before the end of this year to help investors avoid the planned dividend tax hikes. Its 2013 dividend of $9.80 per share, substituting for the regular quarterly dividends next year, will be payable December 27, to shareholders of record as of December 17. The regular dividend currently yields 2.7% on a payout ratio of 31%. The Washington Post Company's competitors The New York Times Company (NYT) and Apollo Group (APOL) do not pay regular dividends. Rival Gannett Co. Inc. (GCI), the owner of USA Today, pays a high dividend yield of 4.5%. Over the past five years, the company's EPS shrank at an average annual rate of 15%, while its dividends increased at a rate of 3.6% per year. The EPS growth rate is forecast to accelerate sharply to an average of 18.1% per year for the next half decade. In terms of valuation, WPO has a forward P/E of 13.5, below its own 5-year average of 33.1. NYT has a lower forward P/E of 11.3. Investment guru Warren Buffett's Berkshire Hathaway is the single largest shareholder in the newspaper company, owning an estimated 1.7 million shares.
Norfolk Southern Corporation (NSC) is a rail transportation company with a market cap of $19.4 billion. The company pays a dividend yielding 3.3% on a low payout ratio of 36%. Its competitors Union Pacific (UNP) and CSX Corp. (CSX) are paying lower dividend yields of 2.2% and 2.8%, respectively. Over the past five years, the company's EPS and dividends grew at average annual rates of 8.8% and 15.1%, respectively. Analysts forecast that Norfolk Southern's EPS will expand at a faster rate of 12.7% per year for the next half decade, which would suggest future dividend hikes. The past financial results were hurt by lower volumes of Appalachian coal shipments, which accounted for 31% of the company's revenue in 2011. However, the rising natural gas prices are improving the competitive position of coal, and coal prices and shipments may improve sometime in 2014. In the meantime, intermodal traffic, accounting for about 20% of sales, is picking up. Moreover, any improvement in macroeconomic conditions will support higher general merchandize traffic, which is dependent on the automotive, chemicals, farm, and paper industries. The company is also improving service capacity and network efficiency as well as buttressing its EPS growth through stock buybacks. Norfolk Southern has an ROE of 18%. Its stock is trading on a forward P/E of 11.3, a discount to its respective industry (with the ratio of 13.2). Legg Mason Capital Management and D. E. Shaw (check out its top positions) have positions in the stock.
Waste Management (WM) is the largest provider of waste management solutions in North America. The company is also one of the major holdings in the Bill & Melinda Gates Foundation Trust (check out its positions), valued at nearly $600 million at the end of the third quarter. The company's dividend is yielding 4.2% on a payout ratio of 76%. Its competitor Republic Services (RSG), another, though a much-smaller holding in Bill and Melinda Gates Foundation Trust, is paying a dividend yield of 3.2%. Over the past five years, Waste Management's EPS shrank by less than 1% per year, while its dividends expanded at an average annual rate of 8.1%. EPS growth is forecast to rebound to an average rate of 7.3% per year for the next five years. The entire waste management sector has experienced slower growth this year, mainly due to restructuring and acquisition charges, lower recycling and electricity prices, and higher operating costs. However, the outlook is rosy given the expected boost in demand from expanding populations and faster long-term economic growth. Waste Management's stock has an ROE of 14%. Based on a forward P/E of 15.2, the stock is trading at a discount to its respective industry (with the ratio of 17.7) and its five-year average ratio. For the reference, Republic Services has a forward P/E of 15.6.
ConAgra Foods, Inc. (CAG) is a consumer and commercial foods producer with brands in nearly 97% of American households. This $12-billion company pays a dividend yield of 3.4% on a payout ratio of 66%. As a share of trailing free cash flow, its dividend payout ratio is lower at 58%. ConAgra's dividend growth over the past five years averaged nearly 6.0% per year. Its peers H. J. Heinz Company (HNZ) and Nestle SA (NSRGY.PK) pay dividend yields of 3.5% and 3.2%, respectively. Over the past five years, ConAgra's EPS grew at an average annual rate of 3.3%. The food producer's EPS growth for the next five years is forecast to accelerate to 6.8% per year, excluding the growth contribution from the company's $5 billion deal to buy private-label company Ralcorp Holdings Inc. (RAH). This deal will make the Omaha, NE-based company one of the world's 20 largest food producers. In particular, ConAgra will become a giant in the production of private-label products, complementing its current broad portfolio of consumer food products. The company has a free cash flow yield of 2.7% and an ROE of 13.6%. As regards its valuation, ConAgra shares have a forward P/E of 14.1, trading at a discount to its respective industry (with a forward P/E averaging 16.9) and H. J. Heinz Company's ratio of 16.7. ConAgra was one of hedge funds' 10 most popular food stocks in the third quarter (check out the full list). Among hedge funds, Adage Capital is especially bullish about ConAgra Foods.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.