By Brandon Hart
Yields on the 10 year Treasury note are at historical lows, and the risk to principal that comes with rising interest rates makes fixed income investments even less appealing. Investors with an appetite for current income will not be able to depend on fixed income instruments- particularly U.S. Treasury issues. There are many exotic and interesting means of improving current income in a portfolio, but dividend investing is an approach that has had a lot of success historically.
In volatile times, dividends provide investors with steady income as well a downside protection thanks to the yield. Considering the dire economic situation facing all developed nations, it makes sense to buy quality stocks with durable competitive advantages. Over the next decade, we believe the following 5 companies can maintain dividend payments and perserve capital. For these reasons we call these stocks "must-own" investments.
Shares of Lorillard, Inc. (LO) currently trade at just under $110 and have a yield of 4.8%. This is 150 basis points above the yield on 30 year treasury bonds, and the stock’s beta of 0.43. Moreover, the dividend has been raised by 41% since mid-2008 and the shares have appreciated 43% over the same timeframe. LO reported earnings that beat analyst expectations with 4 of the last 6 earnings announcements, and trailing ten month earnings are growing faster than the industry. LO is highly leverage with debt to capital ratio of 1.87, but there liquidity and interest coverage is more than sufficient for these debt levels. Competitors Altria (MO) and Reynolds American (RAI) have long been favorites of value investors and dividend investors alike. LO has led peers in terms of share price performance over the last 52 weeks, but the group has generally held up well through the recent wrought and most of the stocks in the group are trading near 52 week highs. The leverage, strong earnings growth, high yield, and low beta, LO is certainly worth considering as for its ability to generate either income or capital appreciation.
Duke Energy (DUK) is a great way to take advantage of the relative leadership among utilities right now. While the S&P 500 is still 16% below the highs from earlier this year, DUK is still trading within 3% of its 52 week high. With a dividend yield at 5.4% (almost twice the 2.84% yield on the S&P 500) and a history of raising it by 13% over the last 5 years, DUK certainly qualifies as a prospect for current income. Peers such as Consolidated Edison (ED) and Progress Energy (PGN) did better at weathering and recovering from the financial crises of 2008, while maintaining or increasing dividend payments. Duke energy’s operating margins are 20.8% compared with industry average of 17.59%, and gross margin is 39.18% compared to 30.19% in the industry. As importantly, the debt position is favorable with the debt to equity, current ratio and quick ratio being as low as they are. DUK can be had at nearly book value and the price to earnings ratio is just 12.3 vs. the industry average of 19.4. DUK is definitely a buy here, but it is more of an average player in a cyclically strong sector.
AT&T (T) is presently trying to acquire Deutsch Telekom’s T-Mobile USA unit, which was blocked by a US Department of Justice lawsuit in late August. Executives on both sides of the Atlantic are working towards a resolution that will allow the deal to close, but the status of government support is more mysterious as German Chancellor Angela Merkel has apparently denied lending her support to the deal. Termination fees on the deal are $3 billion in cash and another $3 billion worth of wireless spectrum and roaming agreements that would be surrendered to T-Mobile, unless it can use one of the out clauses from the merger agreement. T has traded within a few dollars of $30 since late 2008, and the 6.2% yield can be bought cheaply at an earnings multiple of 8. This is not unusual in the telecom industry, but Sprint Nextel (NYSE:S) and T-Mobile are difficult to compare directly due to size differences. Verizon (NYSE:VZ) is quite similar in most respects, but T is a better value on the basis of earnings multiple or book value, and has better growth metrics.
Annaly Capital Management (NLY) is trading on an absurdly low price to earnings ratio of 6.78 but is trading near its 52-week high of $18.79. The payment of dividends and repayment of capital are essential features of REITs, and Annaly has the highest dividend among its peers and has a long history of paying dividends. The dividend yield on the stock is 14.5% and net profit margin is 63.5%. NLY has a return on equity of 17.3%, but given the high degree of leverage in its capital structure, it is important to consider that ROA is only 2.32%. NLY is reasonably valued compared to peers like Boston Properties, Inc. (BXP), or Vornado (VNO), or Equity Residential (EQR), all of which trade at substantially higher multiples of book value and earnings; while offering a fraction of the yield. Armour Residential REIT (ARR) is the closest to NLY in terms of valuation and yield, but lacks the history and earnings stability. NLY is worth buying for the dividend, and the stock can be had for close to book value. That being said, this stock should be approached with caution due to high leverage and the company’s sensitivity to conditions in the real estate market.
Coca Cola (KO) is a significant holding of famed value investor Warren Buffet, and meets many of the criteria on the checklist used by value investors. The yield is 2.7% and the shares trade at a multiple to earnings of 12.9 compared to an industry average of 24.6. KO is less exciting in terms of EPS growth and big share moves as seen with Hanson (HANS), but the net profit margin for the latest twelve months is 29.8%. Moreover, ROA, ROI, and ROE are all well above peers in the non-alcoholic beverage group. Coca-Cola has a major international presence, and though they are facing punitive tax proposals in France, a new plant in Singapore and expansion prospects in China are positive. Coca-Cola already has a market share 0f 61% in China compared to 29% for Pepsi (NYSE:PEP), and is on track to hit $2 billion in sales in the country this year. Coca-Cola has best in class efficiency and arguably has the best known brand in the world and is worth owning on the basis of these characteristics, but Pepsi (PEP) might be more compelling from the standpoint of yield, and valuation multiples.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.