Historically low interest rates have caused investors to seek higher yielding opportunities. Stocks with high yields provide current income and a cushion against capital depreciation. Dividend stocks tend to have strong financial position but it is always critical to check the liquidity and solvency ratios before considering an investment. I have been utilizing a dividend capturing technique for the past few years in an attempt to generate income as well as identify undervalued dividend stocks. For details of the strategy and my screener details, please consult my methodology on the topic (last modified 1/6/2013). In brief, the screen focuses on the relative safety of investments with a concentration on liquid companies at affordable valuations. This is summarized below:
- Dividend Yield ≥ 4.0%
- Ex-Dividend Date = Next Week
- Market Capitalization ≥ $1B
- P/E Ratio: 0-20
- Institutional Ownership ≥ 15%
- Ideally Modest YTD S&P 500 Underperformance
- Minimal European Exposure
After applying this screen I arrived at the equities discussed below. Although I envision these as short-term trading ideas, you still need to exercise caution. The information presented below should simply be a starting point for further research in consultation with your professional financial advisor before making any investment decisions. My goal is to present new companies to you and provide a brief overview of their recent developments; this should not be considered a substitute for your own due diligence.
ARMOUR Residential REIT, Inc. (ARR): 14.01% Yield; Ex-Dividend 1/11
ARMOUR Residential REIT is a company that investments in various agency mortgage backed securities ("MBS") which are issued or guaranteed by U.S. government affiliated agencies. As of the most recent quarter, ARR has $22.1B in agency securities opposed by $19.9B in repurchase agreements. ARR is currently levered about 10X (liabilities/equity) which means its relatively low net return (<2%) is magnified ten times. This explains how these agency REITs can sustain double-digit yields despite such low relative returns on assets. Portfolio Management 101 has an excellent overview of ARR and its risks. As I discussed in a recent mREIT article, in addition to leverage, an important metric for mREITs is book value. ARR has a book value of $7.90 and price/book ratio of 0.89. This indicates that ARMOUR is valued at a modest discount to its financial statement value thus the market is generally cautious. I suspect general uncertainty in the mortgage market is depressing the stock's price. Additionally, concerns regarding the sustainability of the dividend (discussed below) have been weighing on the stock. This discount is generally comparable with peers American Capital Agency Corp. (AGNC) and Annaly Capital Management (NLY).
As a REIT, ARR must distribute at least 90% of its taxable income to shareholders. Currently, ARR distributes 100% of taxable income and may be facing cash flow issues. The company has $193M in cash from operations in the first three quarters while it paid out $187M in dividends to common and preferred shareholders. Such a tight spread is not uncommon for mREITs. ARMOUR simultaneously issued $1.5B in stock which was the financing source that caused cash to increase over the period. With this in mind, the liquidity issue has not been problematic in the last few years as this hot sector of the market has had minimal trouble raising capital due to strong returns. The economic climate could get increasingly more challenging so this is a risk worth noting. The risk is mitigated by bullish insider activity and I believe you should follow management's lead.
December 2012 was a very active month for ARMOUR. The dividend was cut from $.09 to $.08 per month, an 11% decline. This should not be a total surprise as the dividend has declined at least once per year every year since 2010. This dividend decrease was partially offset by the authorization of a $100M stock repurchase plan. This represents approximately 4.6% of the company's current market capitalization which is a meaningful repurchase from a shareholder perspective. Saibus Research concludes that "on a pure price/book ratio, ARMOUR is quite undervalued as its share price is at a 17% discount to its book price [the discount has subsequently declined]. However, we believe that investors are displeased that the company's dividend payment schedule has been 'death by a thousand cuts'". With this information in mind, I believe ARMOUR is reasonably priced at 6.3 P/E and has a high enough yield to compensate investors for the risk assumed. Note that ARR distributes dividends monthly.
Eaton Vance Limited Duration Income Fund (EVV): 7.19% Yield; Ex-Dividend 1/10
Eaton Vance Limited Duration Income Fund is a closed-ended fixed income fund with $2B in net assets managed by Eaton Vance Management. The fund invests in the fixed income markets with an emphasis on junk bonds and domestic senior loans subsets. Junk bonds are rated below BBB- but one of the firm's objectives is to maintain a weighted average portfolio credit quality of investment grade. As the fund name implies, another fund objective is to limit duration, a measure of interest rate sensitivity. This could position the fund well when quantitative easing slows but I do not anticipate that in the near future.
As of the third quarter 2012, nearly two thirds of the portfolio was invested in domestic senior loans and non-investment grade bonds. The balance of the portfolio is invested in investment grade securities including agency MBS, commercial MBS, and investment-grade corporate debt. Effective leverage is around 29% and the fund holds nearly 1,500 investments. This is an interesting fund that invests most capital in risky securities but tempers the risk with a sizable allocation in safer investments. Personally I think there are more secure ways to generate income than to rely on sub-investment grade bonds but this is a fascinating alternative available to investors. Note that EVV distributes dividends monthly.
Darden Restaurants, Inc. (DRI): 4.46% Yield; Ex-Dividend 1/8
Darden is the world's largest full service restaurant company with over 2,000 restaurants in operation. Darden operates famous casual restaurant brands such as Red Lobster and Olive Garden in addition to higher-end restaurants Capital Grille and Eddie V's. Darden's is at a bit of a crossroad as its primary chains are facing slowing growth. For example, same-store sales at the Olive Garden and Red Lobster declined 3.2% and 2.7%, respectively. Quarterly earnings declined 37% due to the poor same-store sales metrics but were also depressed by nonrecurring events such as Hurricane Sandy and the acquisition of Yard House.
The Wall Street Journal recently ran an excellent article on Darden's situation. 95% of Darden's restaurants are comprised of Olive Garden, Red Lobster, and LongHorn; however, those brands accounted for only 76% of total sales growth in fiscal 2012. In the first quarter of fiscal 2013 the store mix is essentially the same but specialty restaurants now account for 37% of total sales growth. This highlights how static the older brands are and the potential for these new restaurants that target "millennials".
Darden is attractively valued with TTM and forward P/Es around 13 but I have liquidity concerns. The current ratio is 0.5 and the quick ratio is nearly 0.2 - both highlight that the company could face difficulty in the near-term. The long-term financial position is not much better as the debt/equity ratio is 1.6. Darden is not alone in performing poorly in the economy as rivals including DineEquity (DIN), owner of Applebee's and IHOP are also losing customers. With the expiration of the two percent payroll tax deduction, I am not optimistic on the prospects for any company that sells predominantly to budget conscious consumers, at least in the short-term. If Darden's executes on its strategy of focusing on millennials I believe the stock could be trading at a P/E closer to 15. The stock has the potential to appreciate more than twenty percent but I would be cautious. If you believe in management's long-term strategy, the 4.5% dividend should provide adequate reward for waiting but this may not be the right stock for the current economic climate.
Shaw Communications Inc. (SJR): 4.21% Yield; Ex-Dividend 1/11
Shaw Communications offers diversified entertainment services, but focuses primarily on Canadian cable television. Cable companies have traditionally been able to distribute sufficient cash flows to investors but the tides are shifting with the rapidly rising cost of content. Sports programming is a double-edged sword because it is one of the biggest advantages over Internet streaming; however, it is the most expensive for cable companies to offer. This is still a 'cash cow' industry but it is changing too quickly for me to fully support investing in it. Companies such as Intel (INTC) and Apple (AAPL) are striving to reinvent the industry and I do not want to bet on traditional cable companies.
Factor in the popularity of Internet connected televisions and other devices and I am not extremely bullish on the traditional entertainment content business model. I do not believe that investors are being adequately compensated for the level of risk assumed and the other companies mentioned offer comparable (or higher) yields for less risk. Five percent seems to be that magic yield number for this type of utility companies that draws support and that could occur again with Shaw. Shaw had a decent year in 2012 with approximate 16% appreciation fueled by surpassing earnings estimates even as revenue dragged. Shaw reports 2013 fiscal first quarter earnings on January 9th so it may pay to wait and see how earnings are before even considering Shaw. Note that Shaw pays dividends on a monthly basis.
Honorable Mentions: AT&T and Verizon
AT&T (T): 5.11% Yield; Ex-Dividend 1/10
Verizon (VZ): 4.65% Yield; Ex-Dividend 1/8
Both telecommunication heavyweights are going ex-dividend this week but both missed the screener this week primarily due to their relative valuations. Both companies struggled in 2012 but have attractive future valuations. Specifically, AT&T and Verizon have P/Es in excess of 40 but both forward P/Es are in the teens. Both are solid, cash rich companies but there is a key difference between the two. Verizon does not own its entire wireless business while AT&T does. Wireless revenue accounts for almost two-thirds of Verizon's revenue so the performance of the two companies could continue to diverge if growth in wireless revenue is sustained. I own both Verizon and AT&T but if I had to choose one I would select AT&T because of its higher yield, lower forward P/E, and iPhone head-start over Verizon. Verizon has the benefit of higher customer satisfaction and lower churn (percentage of subscribers who unsubscribe during a period) but I still prefer AT&T.
The information presented has been summarized below. I make no warranties regarding the information in the chart as industry classifications are frequently imperfect. Yellow and red represent "avoid" and "consider" classifications, respectively.
Additional disclosure: Please refer to profile page for disclaimers.