By Matt Doiron
The Federal Reserve has hinted that it may end its expansionary monetary policies in the coming quarters, and may even begin to shrink its balance sheet within the next few years. If interest rates on Treasuries respond by rising to 3% or 4%, more in line with historical yields, bond investors could suffer losses. While risks might be lower in that situation than from being invested in the market, we think that income investors could consider dividend stocks at fairly low earnings multiples and with at least some recent growth (in theory, if a business has been growing recently it should serve as an indicator for further growth prospects) as alternatives to bonds at this time. We have looked for stocks which satisfy some mix of these criteria and are also fairly well capitalized (minimum market capitalization of $2 billion) and here are five which we think are worthy of further research:
Most income investors are going to be familiar with cigarette stocks. While many of these companies feature earnings multiples in the high teens, Lorillard (LO) trades at only 14 times its trailing earnings. With both revenue and net income up going by recent reports, the stock could be a value play. In addition, it should prove quite attractive to income and defensive investors with an annual yield of 5% and a beta of 0.3. As part of our work monitoring hedge fund activity, we track quarterly 13Fs from hundreds of hedge funds (we have found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year). Our database shows that Renaissance Technologies, whose founder Jim Simons is now a billionaire, increased its stake in Lorillard during Q1 to a total of 4.5 million shares (see Renaissance's stock picks).
It may seem hard to believe, but Gannett (GCI) actually managed slight revenue growth in the first quarter of 2013 versus a year earlier (with growth in the digital and broadcasting segments offsetting a small decline in publishing). Operating and net margins improved; currently, the company gets only 40% of operating income from the better known publishing business. The quarterly dividend payment of 20 cents implies a dividend yield of 3.2%, and that's at a fairly low payout ratio. With the stock valued at 12 times trailing earnings, we don't think that investors should dismiss it merely for being associated with newspapers.
Lockheed Martin (LMT) does not have good short-term growth prospects, due to the likelihood that the U.S. government will reduce its military spending (though the company did grow its earnings last quarter compared to the first quarter of 2012). However, the current dividend yield is above 4% and combined with the fact that markets are not being that optimistic on the stock- the trailing and forward earnings multiple are both 12- we think it's still worth considering. Billionaire Ken Griffin's Citadel Investment Group owned 2.3 million shares at the end of March according to the fund's 13F (find Griffin's favorite stocks).
Oil driller ENSCO (ESV), on the other hand, delivered double-digit growth rates on both top and bottom lines in its most recent quarter compared to the same period in the previous year. The trailing and forward P/Es are 11 and 7, respectively, with the sell-side expecting further earnings growth beyond that point. With a recent increase in its quarterly dividend payment to 50 cents per share ENSCO now pays a yield of 3.4% and it looks to us that the company may have room to boost payments further in the future. However, as a foreign corporation many investors would face higher tax rates on ENSCO's dividends.
The same warning applies to Canadian banks, a number of which offer attractive yields and fairly low valuations; we'll discuss Royal Bank of Canada (RY) here, but similar conditions hold for some of its peers. Royal Bank of Canada trades at 10 times earnings, whether we consider trailing results or analyst consensus for 2014. Its net income was tracking over 25% in its last quarterly report from levels a year ago, which seems out of place given the earnings multiples. The (pre-tax) yield is 4.2%, and while dividend payments do fluctuate over time they were cut only 25% during the financial crisis and were back to normal in two years.