"There is no safety in numbers, or in anything else." - James Thurber
Last week, the market indices posted their best week since December. Equities have now crept back near the levels they began the year at, after posting a better-than-5% decline recently. This sort of volatility was largely absent throughout the ~30% rally in the markets during 2013.
With the Federal Reserve continuing to "taper" and some significant turmoil in key emerging markets (Brazil, India, Turkey, Argentina… etc.), this sort of volatility could be with investors throughout at least the first half of 2014.
Multiple expansion drove the vast majority of gains in 2013, as earnings overall only increased in the 5% range in the preceding twelve months. In addition, the vast majority of stock market gains over the past few years has been directly correlated with Fed actions.
Although the Federal Reserve is still providing some $65B/month in liquidity actions, it is slowly pulling back from previous support levels and should be "neutral" by year-end. Given this, my own expectation is that the market will advance in line with corporate earnings growth, with most forecasts calling for 5% to 10% gains year-over-year in 2014.
2013's rally was primarily driven by growth stocks like Amazon (AMZN), Netflix (NFLX), and the like. These types of plays seem overbought right here after their exponential gains in 2013. Dividend stocks and sectors, after underperforming in 2013, seem like good bets to outperform where market multiples are no longer expanding and interest rates have drifted back in the New Year.
Luckily, there is a bevy of solid stocks with reasonable valuations and yields of at least 3% to pick from in the market currently. Here are a couple of these selections that should do well in 2014, even if not returning the 30% returns investors saw in 2013.
I added to my position to General Electric (GE) during the market's recent decline. There are many things to like about this American manufacturing icon. It yields a robust 3.4% and has raised its payout by 120% since emerging from the financial crisis. With the spin-off of its U.S. consumer finance business later in the year, I expect another significant dividend increase given how much capital the finance business requires compared with its industrial businesses.
General Electric currently stands with its largest order backlog in its history, and should benefit as the situation on the European continent continues to improve. The stock is also a good play on the continued growth in emerging markets long term despite recent turmoil. Its jet engines, locomotives and big-ticket medical machines will continue to see solid demand from these regions of the globe in the years ahead.
The shares are not cheap, but they are not expensive at under 16x this year's expected earnings, right in line with the overall market multiple. General Electric is a nice proxy for the overall market, with a higher dividend yield. The stock is down 10% from recent highs, and its CEO recently made a $1mm purchase.
Summit Hotel Properties (INN) is a hotel real estate investment trust (REIT) focusing on upscale and upper-midscale select-service hotels on a national basis. It has ~90 hotels, with more than 11,000 rooms. Most of its properties are in major metropolitan markets.
The shares yield almost five percent (4.9%). The fundamentals of the hotel industry are quite strong right now, as RevPAR (revenue per room) and occupancy rates continue to rise. Thanks to acquisitions and improving operations, revenue growth should come in at over 60% this fiscal year, with analysts expecting another 20%-plus gain in FY2014.
FFO (Funds from Operations) is projected to increase 15% to 20% in FY2014, and the company has a strong balance sheet with staggered debt maturities. Insiders have been small but frequent buyers of the shares over the last year. Given Summit's yield and growth, INN sells at a very reasonable 10x forward FFO.
Microsoft (MSFT) continues to be one of my favorite "simple and safe" dividend payers. The company sports one of four AAA credit ratings in the S&P, and has more than $60B in net cash & marketable securities on the books. The company is also under new leadership and pushed by activists like ValueAct. I think it will continue to reward investors with increased dividends and stock repurchases. The shares currently sport a 3% yield after raising its payout again in the fourth quarter of last year.
The company has quietly become the second leading "cloud" software player by revenue. It has two cloud businesses (Azure and Office 365) that now have over a billion dollars of annual revenues and showed ~100% growth in the last completed quarter. Server software and Windows licenses also remain strong, posting 12% Y/Y sales increases in the same quarter.
Microsoft should show revenue growth of 6% to 8% annually over the next two years, which is significantly higher than the 4% sales increases expected in the S&P in 2014. Despite this, MSFT sells at under-14 trailing earnings, a discount to the market multiple. The stock is even cheaper given net cash makes up almost 25% of the company's overall market capitalization.
None of these stocks are likely to show the 30% gains the overall market produced in 2013. However, in a more volatile market with much lower returns, their dividend yields, reasonable valuations and solid growth prospects make sense for the income investor who wants to keep it safe and simple.