The first thing an investor should take notice of in today’s market, is that interest rates are both incredibly low - with the 10 year yielding 1.95% at the moment and cash yielding next to nothing – and likely to stay that way.
Those interest rates only exist because there are legitimate fears out there regarding economic activity and hence, earnings. So what can a conservative investor do under such a scenario? One favorite investor strategy is going for dividend yield which is fueled by a confidence that such stocks might be able to endure any short-term market dislocations. However, just screening for yield will turn up a LOT of dangerous situations, where dividend yield will only be high because the dividend is about to be cut.
This article presents a few good, safe candidates for such a yield search. From a larger universe of high yielding companies (the S&P 500 dividend yield is presently over 2.1%), I tried to find a few dividend stocks that were not only yielding close to or over 4%, but also had a very high likelihood of not cutting those dividends.
Here’s what I looked for:
- Medium to large capitalization
A larger capitalization adds a measure of safety and stability, the company is able to issue equity if needed and usually has a better access to credit markets. So I looked for companies with at least $2 billion in market capitalization.
- Low debt/equity
Not having a lot of debt lends more sustainability to keep paying high dividends. This meant only accepting companies with a debt/equity ratio 0.5.
- Rising earnings
Since dividends come from earnings, it’s obvious that companies with rising earnings have an extremely high likelihood of keeping, or increasing, their dividends. So I restricted my search only to companies EPS is expected to go up next year.
- Sustainable dividend payout
Finally, we want the presently high dividend yield not to be a burden on the companies paying it, so we want the dividend payout (the share of earnings that are paid out) to be reasonable to low. Hence, we’ve chosen only companies with a dividend payout below 50%, meaning less than 50% of earnings are going to pay dividends.
- Qualitative exclusions
After searching for the companies that filled the conditions we stated, we excluded those that, for one qualitative reason or another, had a high likelihood of cutting their dividends. This led us to exclude companies such as Banco Santander (STD) due to it being exposed to the Spanish real estate bubble, or Arcelor Mittal (MT) because of its exposure to the highly cyclical steel industry.
Intel’s share price has gone nowhere for a decade. But that’s only its share price. Intel’s earnings and cash-flow have been growing steadily throughout that decade and Intel as built up a strong technological advantage in the market, both in product technology and production technology. This can be seen in the charts (thanks to YCharts, click on each to enlarge) depicting Net Income TTM and Free Cash Flow TTM:
Intel, Free Cash Flow
The combination of a flat stock price with rapidly increasing – and seemingly sustainable - fundamentals has now produced a bargain so obvious, that even Warren Buffett, traditionally averse to investing in technology, has taken a position in Intel. This is not much of a surprise, when you consider the multiples Intel has fallen to:
- PE 2011: 9.3
- PE 2012 (estimated): 8.9
- EV/EBITDA TTM: 4.8
These are very low multiples for a company that’s a clear leader in its space, with a very high ROE (>27%) and no net debt (actually, it holds around $8 billion in net cash, when we account for cash, short term investments and trading assets).
And what is such a bargain yielding? 3.70% ($0.84 yearly dividend, $22.73 share price). Obviously, Intel is also expected to grow earnings during 2012, and its payout for such a lavish dividend comes to just 34.3% of earnings.
There are some threats, namely the tablet revolution, but so far these have mostly meant a lower rate of growth, not some kind of business implosion.
Novartis' business selling drugs cannot be called anything else than stable. The main risk for a drug maker these days is loss of patent protection, but Novartis' estimates don’t indicate any major fear of that happening, so this seems like a stable business to reap dividends from. The net income and free cash flow evolution over the last decade bears this out.
Novartis, Net Income
Novartis, Free Cash Flow
Novartis has also gone mostly nowhere during the course of this decade, and that brought down its price to levels we find attractive. This is how its valuation multiples look today:
- PE 2011: 9.3
- PE 2012 (estimated): 9.0
- EV/EBITDA TTM: 8.1
Again, these are low multiples for such a high quality company and in light of the present interest rate environment. Novartis also has a high ROE at 15.6%. The debt is less favorable than Intel’s, though, with Novartis carrying $18.3 billion in debt, which is still good for a 0.36 debt/equity ratio.
Novartis is presently yielding 3.87% (dividend is $2.00/year). This dividend level amounts to a payout of 47.9% of net earnings, again not as good as Intel’s, but still broadly sustainable.
NYSE Euronext (NYX)
NYSE’s business has been under a lot of competition from ECNs in the US, and of course Europe has a good chance of seeing some economic impact from the present debt crisis. Still, NYSE ‘s competitive position seems good enough that the dividend is under no immediate threat. This competition is not new, and yet, except for some impact from the 2008 recession, net income and free cash flow have recovered nicely.
NYSE Euronext, Net Income
NYSE Euronext, Free Cash Flow
NYSE Euronext took a huge beating in the 2008 recession and between that and competitive fears it never really came back, even though, as we’ve seen, its free cash flow generation and net income recovered their former levels. This made NYSE Euronext a possible bargain here, as the multiples below show:
- PE 2011: 10.0
- PE 2012 (estimated): 9.0
- EV/EBITDA TTM: 7.0
NYSE Euronext carries a lower ROE (9.0%), somewhat pressured both by competition, and a large equity base. The company trades at around book value, given this less than stellar ROE. There’s a bit of net debt in the balance sheet ($1.75 billion), making for a 0.29 debt/equity ratio.
NYSE Euronext is yielding 4.66%, this yield is a bit higher than Intel’s or Novartis’, but that’s understandable given the somewhat lower quality fundamentals. The dividend payout is 48.9%, so also a bit higher than the others, though still within reason.
As always, a deep screening process together with some qualitative filtering and some additional research allowed us to find a few good candidates for your consideration in the context of a dividend yield-seeking strategy. Given what was said above, though, I must add that my personal preference goes towards Intel.