We love to use high yield stocks as bond substitutes in about 25% of our Fixed Income Portfolio. That strategy isn’t appropriate for all investors because it entails assuming additional risk. But for those who can do so, there is little penalty to current income and it offers the opportunity to achieve higher returns. Part of that extra risk is in the form of longer duration (bond maven lingo), which, to ordinary guys like us, means increased price volatility when interests move. Right now, many investors are worried about long term interest rates rising, so the risk in owning a high yield stock is that if rates do increase, a high yield stock may decline more than a long term bond. We don’t happen to be as pessimistic about a move up in interest rates; so we view properly priced high yield stocks as attractive. In addition, if we stick to buying the stocks of companies that are raising their dividends every year, we think some of the ‘duration’ risk can be mitigated.
One company on our Buy List whose stock yields almost as much as a 30 Treasury and which has raised its dividend every year since 2001 is Southern Company (NYSE:SO). This utility supplies electricity to customers in Georgia, Alabama, Florida and Mississippi. The company has grown its earnings and dividends between 2-3% over the last 10 years; but we expect that growth rate to increase due to favorable economic trends in their customer area as well as the company’s excellent record of system reliability and service cost. SO earns between 14-15% return on shareholders equity. The company has strong financials and carries an A rating on Financial Strength from Value Line. Its stock yields 4.6%.
Our Buy Range on SO stock is $35.25-38.75 a share. Our Stop Loss is at $32.25 and we would take profits at $43.25.
EPS: 2006 $2.10, 2007 $2.25, 2008 $2.30
Disclosure: Author is long SO
SO 1-yr chart