3 Dividend Stocks Worth Substituting for Their Corporate Bonds

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 |  Includes: LMT, PG, WM
by: Norman Tweed

Now that S&P has downgraded the US Government debt to AA+ there will be many questions about the interest rates on bonds, mortgages and even CDs. A question that I have is:

Which is safer, bonds with falling credit ratings or common stocks with long histories of raising the dividend?

With the excessively low corporate bond yields (10-yr AAA 2.58%, 20-yr AAA 4.67%), I believe their yields will rise with US Treasury bond yields. In addition, to maintain the equity risk premium, common stocks will rise in price simultaneously.

At present many of David Fish's “CCC” stocks with yields comparable to corporate bonds are at 52 week lows on the price chart. With the rising yields on bonds, the price will fall to obtain the new required market yield. A look at the change in yields on corporate bonds from August 7, 2011 to August 8, 2011 shows the panic drop in rates:

Corporate Bonds

Maturity

Yield

Yesterday

Last Week

Last Month

2yr AA

0.93

0.91

0.99

0.86

2yr A

1.10

1.08

1.11

1.10

5yr AAA

1.41

1.61

1.60

1.69

5yr AA

2.29

2.39

2.36

2.51

5yr A

2.68

2.75

2.65

2.69

10yr AAA

2.58

2.73

2.84

3.26

10yr AA

3.76

3.85

3.79

3.91

10yr A

3.67

3.79

3.86

3.91

20yr AAA

4.67

4.79

5.05

4.85

20yr AA

4.90

5.02

5.29

5.20

20yr A

4.83

4.95

5.22

5.02

Click to enlarge

Data provided by ValuBond.

What should one do in this time of global financial crisis? Many say gold is the thing to shift to. Others say commodities, like farmland or copper. Still others say wait and see what happens when the dust settles. I took care of my treasury bond substitutes last week, with buys of Raytheon (NYSE:RTN) and Nucor (NYSE:NUE) to compliment AT&T (NYSE:T), Dominion (NYSE:D), and Intel (NASDAQ:INTC). My article, 5 Dividend Stocks as Bond Substitutes, explained my reasoning for those picks.

Today I select three corporate bond substitutes from the “CCC” stocks, Procter & Gamble (NYSE:PG), Waste Management (NYSE:WM), and Lockheed Martin (NYSE:LMT).

Corporate Bond Substitutes

  • Procter & Gamble – Dividend Champion with 55 consecutive years of dividend increases, 3.5% yield, 11.6% 5-year annual average dividend growth rate. P/E 15.97
  • Waste Management - Dividend Challenger with 8 consecutive years of dividend increases, 4.32% yield, 9.5% 5-year annual average dividend growth rate. P/E 14.7

  • Lockheed Martin - Dividend Challenger with 8 consecutive years of dividend increases, 4.2% yield, 20.2% 5-year annual average dividend growth rate. P/E 10

A word about valuation. I use a 4% minimum yield for dividend growth stocks. In the above list, PG only has a 3.5% yield. With an 8.4% earnings per share growth rate projected for next year (First Call), the 15.97 P/E would appear high. This was the reason that PG did not make my list of Treasury 30 year bond substitutes. In the more volatile world of corporate bond substitutes, I find the 55 years of consecutive dividend increases, the very consistent 11% dividend growth rate and the 52% total debt/total assets ratio compelling. In addition, this stock has become cyclical with an average price around $60 since 2005.

Waste Management has a total debt to total assets ratio of 70.85%. This, too is a cyclical company averaging around $30 since 2002. The yield + dividend growth rate is close to the P/E of 14.7. The 11.61% earnings per share growth rate projected by First Call for next year reinforces my P/E justification. In fact, with the current yield of 4.32% caused by market price collapse this week, I believe there is an upside to the price to $34, based on a 4% yield.

Finally, Lockheed Martin has a total debt/total assets ratio of 89%. This has been a cyclical company since 1998, with recent average price of $80. The P/E of 10 is more than justified by the yield +dividend growth rate. The projected earnings per share growth rate for next year is 19.2% (First Call). What makes this stock a bargain is the proposed defense budget cuts. I believe that during a time of 2 shooting wars and revolutions throughout the Middle East, the military budget will not be cut as severely as pundits think.

Disclosure: I am long RTN, NUE, T, D, INTC, PG, and I may open a position in WM or LMT within the next 72 hours.