What Smart Investors Buy For High Yields

Includes: CINF, ED, HCP, KMB, LEG, T
by: Avi Morris

Investors are searching for high yields, especially after the Federal Reserve announced that it intends to keep interest rates low for over 2 years. As a result, traditional high yield securities such as junk bond funds, REITs, MLPs and regular stocks are getting a lot of attention.

Junk bond funds don't get a lot of respect as long term investments, but they have done well in the last 10 years (a challenging time for many traditional stocks). These funds are typically at record levels when reinvested dividends are included and fund prices are at or near their highest levels in 3-4 years. Higher prices bring lower yields to around 8% with a few yielding 9-10%. Defaults, a critical expense, are near record lows, making them more attractive for new investors. Even with relatively low yields these rates could last for several years, as they have in the past. The yield spread over the 10 year Treasury is 600 basis points, above the 450-500 narrowest spread in the past.

REITs have been known for high yields and many offer tax advantaged yields in taxable accounts (a portion of dividends are not taxed or taxed at lower rates). A decade ago, yields were 10-12%. Prices have risen sharply in the last 10 years, causing a plunge yields to 3-5% (also partially due to dividend cuts during the recession).

MLPs have an enviable record of growth along with high yields. The Alerian MLP Index started at 100 at the beginning of 1996 and rose to 408. The comparable index with reinvested income is 1240. Very few stocks match or exceed these records. Yields were near double digits in the early years and have dropped to 5.9%, close to the record low 5.37% before the market crash began in 2007. Compared with the low yields on Treasuries, these low yields might continue and go even lower.

Dividends of quality stocks are also attractive for investors seeking high yields. The best are the 51 Dividend Aristocrats (rated by S&P) which have raised annual dividends for at least the last 25 years. Many have streaks of more than 40 years and the elite have track records of at least half a century. A week ago, Coca-Cola (NYSE:KO) extended its streak to 50 years and Johnson & Johnson (NYSE:JNJ) will match that streak in April. Below are 6 of the best with high yields:

Company Yield
AT&T (NYSE:T) 5.8%
HCP, Inc. (NYSE:HCP) 5.1%
Leggett-Platt (NYSE:LEG) 4.8%
Cincinnati Financial (NASDAQ:CINF) 4.6%
Con Edison (NYSE:ED) 4.2%
Kimberly-Clark (NYSE:KMB) 4.1%

(1) AT&T descends from the "Telephone Company." It is known for landlines and has become a leader in mobile broadband and wireless phones used in most countries, along with advanced TV services. Wireless, wireline data and managed services, 76% of the total, should bring mid-single-digit or better earnings growth in 2012. The annual dividend was just increased 4¢ to $1.76. The stock provides a yield of 5.8% and the dividend has been increased for 29 years.

(2) HCP, Inc. is an REIT that invests primarily in healthcare real estate, largely senior housing and related healthcare facilities. Its leverage is conservative (40% debt and 60% equity) with a high credit rating. The dividend was raised 8¢ to $2.00 and has been increased for the last 27 years. The yield is 5.1% (only about half was taxable as ordinary income last year).

(3) Leggett-Platt makes components for bedding, furniture and auto seating. In recent years, annual dividend increases have been limited to 4¢ as earnings have been recovering from recession lows. Analysts are projecting EPS will grow to $1.60 next year which could justify a larger dividend increase. It yields 4.8% and its streak is 41 years.

(4) Cincinnati Financial is one of the 25 largest property casualty insurers. Record-breaking catastrophe losses in 2011 and a decrease from net realized investment gains depleted operating earnings. Dividends have been raised for 51 years, but the 2012 annual increase was only a penny. The yield is 4.6%.

(5) Con Edison is the largest investor-owned utility, supplying needs to the New York City area. The company expects EPS from operations for 2012 to be $3.65-$3.85, up 5% from 2011. Annual dividend increases have been modest, just 2¢ in recent years (including 2012). The stock has done well recently, pulling back from $50 to $35 during the last recession and then rising to $58 with a 4.2% yield. This was the 38th consecutive year of increases.

(6) Kimberly-Clark is a paper company with popular brands such as: Kleenex, Scott, Huggies, Pull-Ups, Kotex and Depend. The stock has been increasing dividends for 40 consecutive years. Unlike the others, KMB has had significant dividend increases, from $1.80 in 2005 to $2.80 in 2011 and increased 16¢ to $2.96 last week (with a 4.1% yield).

These securities are for investors seeking high yields. Capital appreciation will be limited for junk bond funds, REITs and MLPs because of low yields. REITs raise dividends based on higher funds from operations (FFO). However most cut dividends in the recession, reducing their appeal for investors who value long term records. In the last 5 years, income for the Alerian MLP index rose 32%. Distribution increases are expected, if for no other reasons than MLPs are constantly selling more units. The Dividend Aristocrats offer yields above 4% and all are committed to raising dividends. KMB dividends have grown at a 7½% rate in the last 7 years. Faster earnings growth for LEG will bring more substantial dividend increases. The others will likely continue modest increases, better than other companies which had to cut dividends during the recession.

Growth in dividends is how management rewards shareholders. Even with growing dividends, these stocks have their problems (as do all companies) making them less than perfect investments. Because they operate in a variety of business fields, at least one should be helpful for most investors. Growing dividends should generate higher stock prices which is what successful investing is about. If the stock market pulls back, dividends ease the pain.

Disclosure: I am long KO.

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