5 Dividend Stocks for Those that Missed the Rally

The S&P has rallied nearly 50% from its lows and is up over 10% year to date. For those that sat out the rally, afraid to get in, the market is starting to look (at the very least) fairly valued. It’s hard to say where things will go from here. But, a closer look at the leaders of the recent rally sheds some light on some stocks which just might have been overlooked. Not having benefited from the powerful rally we’ve just experienced, it would stand to reason they will have less to correct should the market turn and offer more of an opportunity for appreciation as investors continue to look for uninflated assets.

Click to enlarge:

The above chart graphs the Dow Jones Industrial Average against a proxy for tech stocks (NASDAQ/QQQQ), small cap growth stocks (IJT), and emerging markets stocks (EEM). What we see is that, while Dow Jones has rebounded off of lows, it remains barely positive on the year to date and has severely lagged the three other indexes identified in the chart. Despite being in a recession and all the talk of a “flight to quality,” the Dow Jones seems to have fallen just as hard as any other stock categories yet has been left behind in the subsequent rebound.

It would seem that investors have flocked back into higher risk assets – emerging markets, tech and small caps – before taking a chance on boring U.S. large caps. Now, with the market seeming to be sputtering a bit after such a prolonged bounce, it would seem to be prime time to look at U.S. large caps. These companies due to their size should be leveraged nicely to any sustained rebound in the “real” economy and will likely benefit from a “return to quality” should markets correct.

For those who have sat out the rally still shell shocked by the events of the last 18 months, these stocks continue to pay hefty dividends which, given low interest rates elsewhere, should make them attractive just for their relative liquidity and safety. While I’m not advocating using Dow Jones stocks as a savings account, they can function well for the risk averse, income oriented investor to augment loss of income due to declining interest rates.

Which of the Dow components look most promising? Well if you subscribe to the Dow Underdogs theory, laggards year to date include Exxon (XOM), General Electric (GE), Procter & Gamble (PG), AT&T (T) and McDonald's (MCD).

Personally, I would also like to overlay stocks with dividend/free cash flow between 25% and 50% (the comfortable payout zone). I generally believe that companies paying above 25% of their free cash flow show a true commitment to their dividends while maintaining dividends below 50% of cash flow provides a bit of a safety net in the event of any unforeseen issues in operations.

Doing a quick screen to find Dow components offering dividend yields greater than 3.0%, with a payout ratio within my comfort zone, I found Johnson and Johnson (JNJ), Procter and Gamble (PG), Pfizer (PFE), Merck (MRK), and Caterpillar (CAT). The only crossover between the Dow underdog list and my quality dividend list? Procter and Gamble! I think this one deserves a deeper dive.

Full Disclosure: Author is long shares of JNJ and GE. No positions in any other stock mentioned.

Comments

[sligoo:]

Many mixed signals are floating around about GE. Most that I have read are negative. The reason is GE's financial unit is on thin ice and likely to drag the whole company down.

Aug 20 02:06 PM

[Larry House:]

I agree with sligoo. I question GE, but the others are fine as long-term holdings. Presently I also like MRO, BMY, KFT, VZ, and INTC as strong companies with modest yields. I have positions in these. Defensive stocks are still in vogue and will be for many months to come. I am waiting for a better entry point for emerging markets. There may be better growth prospects outside the US, but in uncertain times worldwide, you can't do better than strong US companies.

Aug 20 02:20 PM

[epeon:]

Well, CAT's latest results are pretty bad. So, I am not a big fan of them. GE shocked me with their accounting fraud. You might say that it is only $50 million but I had a strict policy, when a company is messing with the books, don't buy. You really don't know what else is going on.

As far as XOM, I do like oil as a longterm hold. But, I prefer BP because it pays me a nice dividend while I wait.

Aug 20 02:26 PM

[market ace:]

Your divy stock picks obviously have better yields than Treasuries and better than most stocks, but still appear dangerous to me as all have declining earnings and revenues flat to declining, especially CAT, which pushes their P/E's too high. Their growth prospects also appear very limited any time soon so it appears that a down bias is much more likely and earning 3% with the potential to lose 25% (based on their average 52 week lows) does not appeal to me at the present time.

These will probably be excellent buys after Wall Street returns to reality again after the next big down turn, which has to come as the economy has a long way to go to reach a positive growth status.and more tough times lay ahead.

Aug 20 02:50 PM

[drone:]

Immelt has used every trick in the book to deceive investors, buyer beware.


On Aug 20 02:26 PM epeon wrote:

> Well, CAT's latest results are pretty bad. So, I am not a big fan
> of them. GE shocked me with their accounting fraud. You might say
> that it is only $50 million but I had a strict policy, when a company
> is messing with the books, don't buy. You really don't know what
> else is going on.
>
> As far as XOM, I do like oil as a longterm hold. But, I prefer BP
> because it pays me a nice dividend while I wait.

Aug 21 04:19 AM

[David Van K...:]

I think that apples and oranges are getting mixed up here. There are two fundamental strategies for making money from the stock market: capital appreciation and dividends. I think it is wise to set up a strategy for one or the other, or both (in separate portfolios), and then execute that strategy as best you can. Mixing up the two strategies can get you into trouble.

For dividend investing: Keep your eye on the ball--it's the dividend stream, and its growth over time. Don't buy a stock for a dividend portfolio because you think its price is going to go up--that's mixing up the strategies. Buy a dividend stock because you are satisfied with its initial yield and also believe that its dividend is reliable and going to grow.

Here's where I think apples and oranges are being mixed in the article and the comments:
--Overlaying the Dogs of the Dow theory (which is about capital appreciation) with dividends.
--GE: This can't be a worthy dividend stock, they just cut their dividend! If you want to make it part of a capital appreciation strategy, fine...but some of the risks are described in the comments.
--CAT: I'm not personally familiar with them, but the dividend question would be, is the dividend safe and is it growing? Does it have sufficient current yield (say >3%)? If so, buying it at a down point might be a great move. It's yield to you ("yield on cost") will only go up as long as you own it. Based on one set of comments, the key question would appear to be, is the yield safe and growing? If the company's financials are shaky, the answer might be "no." Then it's not a candidate.

The author's final recommendation, PG, is a terrific dividend company, not to mention a terrific company period. Its dividend is utterly safe.

Aug 21 08:35 AM

[YoYoMama:]

ALWAYS buy a dividend stock with an eye on its capital appreciation potential. It makes no sense to buy into a stock where every fundamental and technical indicator says it will depreciate.

In this market, you MUST have some room to breath, because it is giving us plenty of reasons to sell, rather than to buy. Would you rather sell at a gain, or loss?

I agree with David most of the time (and am a follower), but I must disagree with him that you cannot mix strategies. I am successfully doing so, while beating the market.

Use the strategies that work for you.


On Aug 21 08:35 AM David Van Knapp wrote:

> I think that apples and oranges are getting mixed up here. There
> are two fundamental strategies for making money from the stock market:
> capital appreciation and dividends. I think it is wise to set up
> a strategy for one or the other, or both (in separate portfolios),
> and then execute that strategy as best you can. Mixing up the two
> strategies can get you into trouble.
>
> For dividend investing: Keep your eye on the ball--it's the dividend
> stream, and its growth over time. Don't buy a stock for a dividend
> portfolio because you think its price is going to go up--that's mixing
> up the strategies. Buy a dividend stock because you are satisfied
> with its initial yield and also believe that its dividend is reliable
> and going to grow.
>
> Here's where I think apples and oranges are being mixed in the article
> and the comments:
> --Overlaying the Dogs of the Dow theory (which is about capital appreciation)
> with dividends.
> --GE: This can't be a worthy dividend stock, they just cut their
> dividend! If you want to make it part of a capital appreciation strategy,
> fine...but some of the risks are described in the comments.
> --CAT: I'm not personally familiar with them, but the dividend question
> would be, is the dividend safe and is it growing? Does it have sufficient
> current yield (say >3%)? If so, buying it at a down point might be
> a great move. It's yield to you ("yield on cost") will only go up
> as long as you own it. Based on one set of comments, the key question
> would appear to be, is the yield safe and growing? If the company's
> financials are shaky, the answer might be "no." Then it's not a candidate.
>
>
> The author's final recommendation, PG, is a terrific dividend company,
> not to mention a terrific company period. Its dividend is utterly
> safe.

Aug 21 08:43 AM

[Advill:]

No such a big deal in this, there are many companies with excellent dividends history and great potencial of value like XOM,BP,E, WIN, etc. with +6% yield....so what?

Aug 21 11:05 AM

[Dividend Di...:]

In response, I quote another dividend enthusiast. Greg Donaldson writes at risingdividendinvestin... in a March 16th post titled, In the long run, Price Follows Dividends--Part II:

"If a company is giving its shareholders their fair cut of the profits, it should show up in the stock price. The stock market is a pricing machine. The more transparent a company is with their dividend policy, the more accurately the market will price their stock."

and later..."Dividends not only contribute directly to investment returns because they are real money, but they also have predictive powers for stock price appreciation, as well." See also the Table with Greg's article.

So if I understand Greg correctly, if you're doing adequate research and investing in only the best of breed dividend stocks, price appreciation should follow.

Thus, if you follow a sound dividend growth strategy...you're already keeping your eye on price appreciation. They are interwined, not separate philosophies. In theory, if I buy a great dividend stock, the price appreciation should be trending higher, and if it dips, then I should buy more.

YoYoMa--I think your point is one in the same with David's. In order to be "satisfied with the yield," as David says, then you have to have done your homework on the current and future expectations of the price. No one can call bottoms, so if the price is trending down, but the fundamentals are there, maybe you are initiating a position, will add on dips, and can expect, as Greg says, long term price appreciation to follow expected dividend growth.

Enjoy reading each of you and would love to hear thoughts.

-DD

On Aug 21 08:43 AM YoYoMama wrote:

> ALWAYS buy a dividend stock with an eye on its capital appreciation
> potential. It makes no sense to buy into a stock where every fundamental
> and technical indicator says it will depreciate.
>
> In this market, you MUST have some room to breath, because it is
> giving us plenty of reasons to sell, rather than to buy. Would you
> rather sell at a gain, or loss?
>
> I agree with David most of the time (and am a follower), but I must
> disagree with him that you cannot mix strategies. I am successfully
> doing so, while beating the market.
>
> Use the strategies that work for you.

Aug 21 05:06 PM

[Robert A. W...:]

I would enjoy an explanation of how indicators like an average market P/E based on 1-year earnings of 53 and P/E based on 10-year average earnings (the Graham & Dodd and/or Shiller P/E) of 20+ imply a "fairly valued" stock market. Please provide your readers with greater specifics, because to fundamentalist, it's 2003 all over again -- the start of another "faux" bull market beginning from super-high P/E ratios, where it will take years for the average market P/E ratio to compress back to average, and immediately thereafter half a decade worth of gains will be erased in the blink of an eye. Enlighten us, please.

Aug 21 06:57 PM

[Dividend Inc:]

Greetings DD,

I think that your insights on GD's method are solid and strike to the core of why dividend investing isn't about giving up growth and capital appreciation. GD's approach sounds similar to Geraldine Weiss' Dividends Don't Lie book. Thanks.


On Aug 21 05:06 PM Dividend Disciple wrote:

> In response, I quote another dividend enthusiast. Greg Donaldson
> writes at risingdividendinvestin... in a March 16th post titled,
> In the long run, Price Follows Dividends--Part II:
>
> "If a company is giving its shareholders their fair cut of the profits,
> it should show up in the stock price. The stock market is a pricing
> machine. The more transparent a company is with their dividend policy,
> the more accurately the market will price their stock."
>
> and later..."Dividends not only contribute directly to investment
> returns because they are real money, but they also have predictive
> powers for stock price appreciation, as well." See also the Table
> with Greg's article.
>
> So if I understand Greg correctly, if you're doing adequate research
> and investing in only the best of breed dividend stocks, price appreciation
> should follow.
>
> Thus, if you follow a sound dividend growth strategy...you're already
> keeping your eye on price appreciation. They are interwined, not
> separate philosophies. In theory, if I buy a great dividend stock,
> the price appreciation should be trending higher, and if it dips,
> then I should buy more.
>
> YoYoMa--I think your point is one in the same with David's. In order
> to be "satisfied with the yield," as David says, then you have to
> have done your homework on the current and future expectations of
> the price. No one can call bottoms, so if the price is trending
> down, but the fundamentals are there, maybe you are initiating a
> position, will add on dips, and can expect, as Greg says, long term
> price appreciation to follow expected dividend growth.
>
> Enjoy reading each of you and would love to hear thoughts.
>
> -DD
>
> On Aug 21 08:43 AM YoYoMama wrote:

Aug 23 02:48 AM

[TCK:]

Even if you believe in this "recovery", won't there be a better entry point between now and November ?

Aug 23 08:14 PM