The High-Yield Vs. Low-Yield Battle

by: Eli Inkrot


In two previous articles I reviewed how the highest- and lowest-yielding Dividend Champions got to where they are today.

This article pits the four highest-yielding companies against the four lowest-yielding companies.

In the end, it all comes down to the individual company, valuation and expectations.

In two recent articles, I detailed the various histories of both the lowest- and highest-yielding Dividend Champions -- companies that have not only paid but also increased dividends for at least 25 years. In the lowest-yielding article, I looked at 5 companies with a dividend yield of less than 1%: C.R. Bard (NYSE:BCR), Energen Corp (NYSE:EGN), Franklin Resources (NYSE:BEN), Nordson Corporation (NASDAQ:NDSN) and Sigma-Aldrich (NASDAQ:SIAL). The lesson gleaned from this commentary was that a low yield precludes neither a reasonable stream of income nor solid returns.

In the highest-yielding article, I examined 4 companies with a beginning dividend yield above 5%: Universal Health Realty Trust (NYSE:UHT), HCP, Inc. (NYSE:HCP), Mercury Corporation (NYSE:MCY) and AT&T (NYSE:T). This review found that the high yield often came at the expense of lower growth or a seemingly less secure payout.

As a bookend to these reviews, I thought it might be interesting to compare or "battle" the two types of companies going forward. Previously the articles only looked through the lens of history, but today we'll make some guesstimates about the future.

For the sake of activity I'll pick a "winner" for each pairing, yet by no means does this suggest a recommendation; it's just a fun exercise. Further, you should always complete further due diligence -- whether we're talking about investment decisions or a grocery store product I happen to mention. With that being said, here's how I'd go about thinking through these high-yield/low-yield matchups.

C.R. Bard vs. Universal Health Realty Trust

This first coupling pits the lowest yielding Dividend Champion -- C.R. Bard -- against the highest-yielding Dividend Champion -- Universal Health Realty Trust. If we were to take a 5-year forward looking "income only" time horizon, it seems that Universal Health would be the overwhelming income favorite (its "current" yield is nearly 10 times that of BCR). However, on a total return basis, the comparison becomes more interesting.

C.R. Bard has a current price around $150 and pays out just $0.88 in the form of a dividend on an annual basis. According to S&P Capital IQ, analysts expect the company to pay out a little over $5 in cumulative dividends over the coming 5 years -- for an income return of just 3.5%. Value Line expects earnings per share to be around $11 in the 2017 to 2019 range, while analysts reporting to MSN Money expect 13% annual growth -- which would put the 5-year EPS estimate around $13. We'll split the two and call it $12 in 5 years' time. Over the past 15 years, the company has had a "normal" P/E ratio around 20. Since 2009 it's been closer to 16, so something around 18 appears reasonable. Overall, this suggests a price return of 44% and an estimated total annualized return 8% during the next half decade.

Estimates for Universal Health Realty Trust are a bit more difficult to find. However, we do have a few clues. The company has increased its dividend for 28 straight years, with payout boosts in the last 8 years coming in at 1%-2%. Further, since 2000, funds from operations grew by just 0.5% annually. Thus, you would likely want to have some solid reasoning to project faster growth for this company. Without diving further into the business, I personally don't have much insight, so 2% growth will have to suffice for this high-level look. A 2% growing dividend and price results in $13 in collected dividends and a price around $49. This represents a 41% total return, with the majority of that coming from the dividend, for an estimated total annual return of about 7%. Add in the idea that the UHT dividends are taxed as ordinary income in a taxable account and the hat tip for this matchup goes to C.R. Bard.

Energen Corp. vs. HCP, Inc.

According to Value Line, Energen is expected to generate something in the vicinity of $3.50 in dividend payments over the next 5 years while earning around $6.50 in the 2017 to 2019 range. Since the recession, the "normal" P/E ratio has been somewhat skewed due to cyclicality in business results, but prior to that the company regularly traded at about 15 times earnings. This would represent total annualized returns of 5.5%.

Like Universal Health Realty Trust, HCP Inc. is a high-yielding slow-growing healthcare REIT. However, its previous and future prospects appear a bit clearer. Since 2000, the company was able to grow FFO by about 4.5% annually, while the dividend increased at a rate of about 3% per year. Analysts expect FFO to grow by 4% a year and the dividend to climb 3.3% annually -- both of which appear reasonable. Keeping the same valuation, this represents an estimated total return of just over 8.4%. Despite the potential tax disadvantage, the nod for this matchup goes to HCP, Inc.

Franklin Resources vs. Mercury General

Franklin Resources is expected to generate a little over $3 per share in dividends during the next half decade. Additionally, analysts expect earnings per share to be in the $5-$6 range in 5 years' time with a very solid expected growth rate. Since 2000 the company has had a "normal" P/E ratio around 17, but since the recession this has been closer to a multiple of 15. We'll use a conservative multiple of 15 and $5 in EPS to get to an annualized total return of 7.3%.

As described in a previous article, Mercury has recently been paying out over 100% of its profits in the form of a dividend. Clearly this is unsustainable, and management has made it known that it recognizes this and hopes to grow out of it. As such, anticipating lower dividend growth might be prudent. S&P Capital IQ anticipates 5-year earnings per share to be around $2.80, while Value Line is more upbeat with expectations of $3.60 in earnings during the 2017 to 2019 time period. Analysts reporting to MSN Money suggest just 2% intermediate growth, so we'll use some caution and suggest $3 in earnings. Assuming a P/E of 15 and a surviving dividend, this would equate to an estimated total return around 3%. Add in the idea that Franklin Resources has paid a special dividend 4 times since 2005, and BEN is the matchup winner.

Nordson Corporation vs. AT&T

Nordson is expected to grow quite fast over the intermediate term -- with estimates in the 10-15% range. The EPS estimate is around $5.50, while NDSN has generally traded in the 17 to 19 P/E range. At 18 times future expected earnings, this would indicate a price around $100. Add in $5 in expected dividends and the estimated total return would be around 5.6%.

Despite its slow dividend growth rate, AT&T is expected to generate around $10 in dividends over the next 5 years. In singularity this means nothing, but when compared to a $34.50 price, this means an investor might receive 30% of their initial capital back in payments alone. The company isn't expected to grow incredibly fast, with 5-year estimated earnings per share in the $3 to $3.50 range. However, even when using the low earnings number and a 14 P/E, this would still represent a nearly 11.2% estimated total return. AT&T likely takes this one from the get-go as its dividend yield nearly matches a prudent expectation of Nordson's total return.

In sum, both the higher-yielding companies and lower-yielding companies each "won" two matchups. Interestingly, both sets of four companies had average expected total returns around 7%.

In the end, everyone has varying objectives and expectations. That's why there's a market -- a buyer for every seller. Further, as suggested above, a high or low starting yield doesn't appear to materially drag or push the expected total return. It's the individual companies, valuations and expectations that matter.

In this example, I matched up drastically different yields and found "winners" on both sides. Now it is true that 5 years probably isn't enough time to truly "pick" a better or expected "winner." And it follows that I certainly wasn't recommending any of these companies. However, it is also the case that the first few years out give us the best chance for "being in the ballpark" with our estimates.

Here's the takeaway: it can be all too easy to cast aside the low-yielding companies in search of income or the high-yielding ones in search of growth. However, as we've just witnessed, such arbitrary dividing lines likely hamstrings the process more than they help. The most important part is to first consider what your goals are, then to seek out partnership decisions that you believe have a reasonable probability of matching those objectives. Happy seeking.

Disclosure: The author is long T.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.