Is it time to flee to safety? With the economic and political climates only becoming more tumultuous I have been concentrating on high yield equities recently. We all know about the blue chip dividend companies but there are attractive companies with high yields that are going ex-dividend every week. This strategy can work in one of two ways: either you buy before the ex-date to receive the dividend or buy after if the stock declines far below the after-tax amount of the dividend.
Buying the stock to receive the dividend is intuitive but many have contacted me requesting further details on the second strategy. Investopedia has a great example of how this works. To explain this, I will use AT&T (T) as an example. AT&T declared a $.44 dividend to shareholders of record on January 10th, 2012. On the ex-dividend date the stock price should decline by the after-tax dividend amount, with an assumed tax rate of approximately 15% because many dividends qualify for a preferential tax rate. As a result, an investor would expect the stock price to decline by $.37 = [$.44 * (1-.15)]. If AT&T declined by more than $.37 in the absence of negative news you might have an attractive opportunity. Executing this strategy can generate outsized returns over short periods of times but should only be performed on companies that you would be comfortable owning.
To focus on these opportunities I ran a screen with a focus on relative safety for the investments. Since this is a high yield quest I began with a specification of a dividend yield greater than four percent and an ex-dividend date within the next week. To provide some layer of safety I narrowed down the environment by looking at companies with market capitalizations greater than $1B, PEs between zero and twenty, and institutional holding percentage of at least ten percent. While not a precise requirement, I prefer companies that have underperformed the S&P 500 in the last 52 weeksas it indicates limited downside relative to peers. This is summarized below:
- Dividend Yield ≥ 4.0%
- Ex-Dividend Date = Next Week
- Market Capitalization ≥ $1B
- PE Ratio: 0-20
- Institutional Ownership ≥ 10%
After applying this screen I arrived at five potential trades. Although I envision these as short-term trading ideas, you still need to be careful. The information presented below should simply be a starting point for further research and should not be taken as a recommendation.
Prospect Capital Corporation (PSEC): 11.65% Yield - Ex-Dividend 1/27
Prospect Capital is a specialty finance company that operates primarily in the private equity and specialized investment categories. As with many of the companies that appear in my dividend screens it appears that PSEC is depressed solely because it is a financial services company. Private equity companies are attractive dividend producers because they often either turnaround or improve existing companies and are able to return excess cash quickly. These can be volatile companies because their ventures often do fail but once they have successful investments, they can pay higher than average dividends. The firm prefers to make small investments ($5-$50M) in small-to-mid size North American companies. In June 2010 Prospect began distributing dividends monthly rather than quarterly which accounts for the perceived dividend decrease from $.40 to $.10. The dividend has held steady around $.10 per share since then but with such a high current yield dividend growth is not a requirement. I am confident in the company's immediate term prospects primarily because the company announced a $100M repurchase plan in August. Please note that Prospect makes monthly distributions, so you are still looking at approximately one percent in income, similar to the other companies below. Since I first wrote about Prospect in October the yield has declined nearly two percent as the stock price has appreciated.
R.R. Donnelley & Sons Company (RRD): 8.52% Yield - Ex-Dividend 1/25
R.R. Donnelley is one of the largest printing companies and has the distinction of having the second highest dividend yield in the S&P 500. The dividend has been flat for at least six years and it is probable that it declines before it rises. To make matters worse RRD has red flag accounting issues. This week the company announced that it is "unable to provide GAAP operating earnings estimates for fiscal 2011 at this time as it determines the impact of 'a pension curtailment gain, acquisition-related expenses and other items.'" In summary, RRD is a classic dividend trap: earnings quality is deteriorating, the payout ratio is too high (90%), and there are accounting difficulties.
Royal Bank of Canada (RY): 4.01% Yield - Ex-Dividend 1/24
The Royal Bank of Canada ("RBC") is one of the world's largest diversified banks with services ranging from commercial banking to investment banking to wealth management. Over half of the company's profits come from vanilla Canadian banking services, while less than twenty percent comes from the more volatile international banking and wealth management segments. While hundreds are protesting Wall Street, RBC has thus far been flying under the radar as our neighbor to the north. The stocks appreciation in the last quarter has caused the dividend to slide down sixty basis points but the four percent yield is still high attractive.
El Paso Pipeline Partners, LP (EPB): 5.72% Yield - Ex-Dividend 1/27
TC PipeLines is a master limited partnership (MLP) that owns interest in companies that operate thousands of miles of natural gas pipelines spanning the Midwest U.S. and Canada. This is a highly lucrative business considering its low relative risk: TCLP's profits are not overwhelmingly tied to energy prices as the pipeline operators charge for the privilege of using the pipelines. Volume will differ as the underlying resources prices change, but not dramatically. Revenue is not growing as fast as peers but an eighty percent profit margin cushions the blow. TCPL edges out El Paso Pipeline Partners due to its significantly higher yield, S&P 500 underperformance, and lower PE.
Alliant Energy Corporation (LNT): 4.18% Yield - Ex-Dividend 1/27
Alliant Energy Corporation is a regulated utility company that produces and distributes energy for 600,000 customers in the Central United States. While slight geographical differences exist for regional utilities, the underlying business is essentially the same: a stable, cash-cow business that returns most profits to investors via dividends. I have successfully owned utility companies in the northeast US with tremendous success in the form of both capital gains and income.
Alliant Energy Chairman and CEO William Harvey announced on Friday that he would be retiring effective March 31st. Patricia Kampling, COO, will replace Mr. Harvey as Chairman and CEO. This management shift could cause greater than usual volatility for the company in the upcoming months.
The information presented above has been summarized below.