In this article, I analyze five stocks that could, when put together, form a diversified income-producing portfolio. I chose these stocks from stable sectors and identified them based on the discount at which they are selling relative to their peers on a discounted cash flow basis. The five sectors that I have focused on for this article are consumer staples, consumer discretionary, telecommunications, utilities and materials. As always, use my analysis as a starting point for conducting your own investigation and analysis prior to making any investment decisions.
Kimberly-Clark Corporation (KMB)
Operating in consumer staples, Kimberly-Clark manufactures and markets health care and personal care products worldwide and has a market cap of $28 billion. It has a 52 week trading range of $61 to $74.25 and is now trading at around $72, with a trailing PE of 17.
Kimberly-Clark pays a solid dividend yield of 4%, which is the fourth highest in its industry and higher than Colgate-Palmolive's (CL) 3%, and Procter and Gamble's (PG) 3%. It has a return on equity of 28%, which is lower than Colgate-Palmolive's 87% and higher than Procter and Gamble's 18.
Kimberly-Clark saw a 3% drop in third quarter 2011 earnings to $5 billion and net income drop by 7% to $401 million. For the same period Kimberly-Clark's balance sheet strengthened with cash and cash equivalents rising 36% to $1.2 billion, with long-term debt remaining steady at $5.8 billion.
In addition, Kimberly-Clark's dividend yield of around 4% is higher than both ten year Treasuries and the U.S. inflation rate for December 2011 of 2.96%. The company also has a strong dividend payment history, having consistently paid a steadily rising dividend since 1985. This dividend has increased in value since then by 866% to $2.80 per share. Currently Kimberly-Clark has a dividend payout ratio of 66% and both this and its dividend history indicate the company is able to maintain its dividend payment.
The earnings outlook for Kimberly-Clark is quite solid due to its strong market position in non-cyclical paper, health and hygiene-related consumer products. It also has a portfolio of established brands all of which are consumer staples and have relatively inelastic demand. Finally, at current prices I believe the stock is undervalued as it has an earnings yield of 6%, which is more than double the risk free rate. This represents a healthy risk premium for a company operating in the consumer staples sector.
Leggett & Platt (LEG)
After the consumer staples sector, my next pick is in the consumer discretionary sector and I have selected Leggett & Platt, a company that many of you may not be aware of. The company designs and produces various engineered components and products worldwide including residential furnishings and commercial fixtures. It is a small cap company with a market cap of $3 billion. It has a 52 week trading range of $17.80 to $26.95 and is currently trading at around $23 with a trailing PE of 20.
Leggett & Platt has a dividend yield of 5%, which is more than double the ten year Treasury bond yield and higher than the U.S December 2011 inflation rate of 2.96%. It is also is difficult to find a yield this high in the consumer discretionary sector and it is the highest dividend yield in the home furnishings and fixtures industry. It is superior to Hooker's (HOFT) 3% and Sealy's (ZZ) 0%. It has a return on equity of 12%, which is higher than Hooker's 3% and marginally lower than Sealy's 13%.
For the third quarter 2011, Leggett & Platt saw a 0.5% drop in earnings to $940 million, and an 18% drop in net income to $45 million. For the same period Leggett & Platt's balance sheet strengthened with cash and cash equivalents rising 8% to $219 million, although long-term debt also rose by 5% to $897 million.
The company has a strong dividend payment history, having consistently paid a steadily rising dividend since 1988. This dividend has increased by 1,300% since then, to its current value of $1.12 per share. The company has a dividend payout ratio of 92%, which as a quick and dirty measure of dividend stability does not bode well for the company's dividend stability. However, many analysts have forecast that the company's earnings will grow meaningfully over 2012 due to improving U.S economic sentiment. This in my opinion should see an increase in the dividend in 2012.
I also believe that the company's profit margin of 5% is indicative of further net income growth, being higher than both the five year minimum of -20% and average of 3%. My only concern is the stocks beta of 1.27, which indicates that the stock price is more volatile than the market, although this is something to be expected from a small-cap. Finally, at current prices I believe the stock is fairly valued with an earnings yield of 5%, allowing for a small risk premium over the current risk free rate of ten year Treasuries.
Now let's dive into my pick for the telecommunications sector and here I am looking at the Australian company Telstra. It is the largest telecommunications provider in Australia and provides telecommunications and information services to individuals, businesses, and governments and enterprises in Australia and internationally. The company has a market cap of $44 billion, a 52 week trading range of $12.65 to $17.62 and is now trading at around $18, with a trailing PE of 13.
Telstra holds a dominant position in the Australian telecommunications market and pays a solid dividend yield of around 8%, which is higher than AT&T's (T) 6% and Verizon's (VZ) 5%. Its return on equity of 26% is also higher than AT&T's 10% and Verizon's 5%. This dividend is also higher than my two key measures, firstly the U.S inflation rate, which for December 2011 was 2.96% and secondly ten year Treasury bond yields.
Telstra saw a 3% rise in first half 2011 earnings to $13 billion, and during this period net income rose by a massive 71% to $2 billion. For the same period Telstra's balance sheet weakened with cash and cash equivalents dropping 5% to $2.7 billion and long-term debt rising 2% to $12 billion.
The company also has a strong dividend payment history, having consistently paid a steadily rising dividend since 2002. This dividend has increased by 137% since then, to its current value of $1.40 per share. It is also a mature company holding a dominant position in a mature telecommunications market, which supports its dividend payout ratio of 98%. Overall, this bodes well for Telstra being able to maintain its dividend payout over the short to medium-term. In my opinion, the stock is also undervalued at current prices as it has an earnings yield of 8%. This is more than triple the risk free rate of ten year Treasury bonds and represents a buying opportunity at that yield.
American Electric Power Company (AEP)
My next stock is from the utilities sector, which is known for its earnings stability and lower stock price volatility. From this sector I have selected American Electric, which has a market cap of $20 billion and is the fifth largest electric utilities company in the U.S. The company has a 52 week trading range of $33.09 to $41.98 and is now trading at around $41 with a trailing PE of 11.
American Electric has a solid dividend yield of 5% and this is higher than many of its competitors, including Southern (SO) and NextEra (NEE), both of which have yields of around 4%. Its return on equity of 13% is also greater than Southern's 9% and NextEra's 10%.
For the third quarter 2011, American Electric saw a 20% rise in earnings to $4 billion and a massive 164% rise in net income to $928 million. During this period it reported a stronger balance sheet with cash and cash equivalents rising by 21% to $608 million and long-term debt dropping by 2% to $15 billion.
American Electric has a solid dividend payment history, having consistently paid a dividend since 1971. The company also has a dividend payout ratio of 49%, which bodes well for its ability to sustain its dividend payment. I also quite like the company's debt to equity ratio of 0.77, which indicates a strong balance sheet and further supports my view that its dividend is stable. American Electric also has a beta of 0.40, which in my opinion is a big plus when selecting a stock for a diversified income portfolio. This indicates that it has relatively low price volatility, boding well for the reduced likelihood of capital loss over the long-term.
Finally, I find American Electric's earnings yield of 9% quite compelling as in my opinion it indicates that the company is undervalued by the market at the current price. This earnings yield is more than triple the risk free yield and therefore presents as a buying opportunity.
Terra Nitrogen (TNH)
My final pick is from the materials sector and I have chosen an agricultural chemicals producer Terra Nitrogen. Interestingly, this company is a partnership and as a result is obliged by the partnership agreement, to distribute each quarter 100% of its "available cash", as defined by the partnership agreement. Terra Nitrogen produces and sells nitrogen fertilizer products for agricultural and industrial applications and has a market cap of $3.6 billion. It has a 52 week trading range of $101.21 to $199.50 and is trading at around $190 with a trailing PE of 13.
I have chosen Terra Nitrogen for its dividend yield of 9%, which is the highest in its industry and higher than Potash Corporation's (POT) 0.6% and Monsanto's (MON) 1.5%. Its return on equity of 182% is also the highest in its industry and greater than Potash Corporation's 38% and Monsanto's 14.5%. Its dividend yield also meets my requirements of being greater than both the U.S inflation rate, which for December 2011 was 2.96%, and the yield of ten year Treasuries.
Terra Nitrogen has seen third quarter 2011 earnings rise 2.4% to $203 million and net income drop slightly by 0.4% to $128 million. Its balance sheet has weakened during this period, with a 6% drop in cash and cash equivalents to $144 million.
The company also has a strong dividend payment history, having consistently paid a dividend since 1992. This dividend has increased by 554% since then to its current value of $15.84. The company also has the dividend well covered with a dividend payout ratio of 81%, despite being compelled to distribute all available cash.
I also like this company due to its debt free balance sheet, which bodes well for net income and dividend stability. Plus its stock price has quite low volatility with a beta of 0.30, which bodes well for mitigating the risk of capital loss.
Finally, despite trading at close to its 52 week peak, the company has an earnings yield of 7%. This is more than triple the current ten year Treasury bond yields, thus indicating that the company is undervalued even at its current price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.