We love dividend stocks because they usually have better risk-return combinations than the rest of the market. They won't make you rich, but they will help you stay rich. In this article, we are going to take a closer look at a few high dividend stocks with the highest number of hedge fund positions. We limited our analysis to U.S. stocks with at least $10 billion market cap and dividend yields of above 5%. Hedge funds generally do not invest in dividend stocks for their high dividends. Instead, they want to achieve capital gains in a year or two and they don't mind receiving high dividends while waiting for their positions to appreciate significantly.
No of HFs
Eli Lilly & Co (NYSE:LLY)
Verizon Communications Inc (NYSE:VZ)
Exelon Corporation (NYSE:EXC)
Altria Group Inc (NYSE:MO)
Reynolds American Inc (NYSE:RAI)
AT&T, Inc (NYSE:T)
CenturyLink, Inc (NYSE:CTL)
Eli Lilly & Co is the most popular high dividend stock among hedge funds tracked by us. It has a dividend yield of 5.07% and there were 32 hedge funds with LLY positions in their 13F portfolios at the end of 2011. For example, Jim Simons' Renaissance Technologies had over $300 million invested in Eli Lilly at the end of last year. Ray Dalio, Israel Englander, Ken Fisher, and Jacob Gottlieb were also bullish about Eli Lilly.
Eli Lilly's patent on Zyprexa recently expired. Its patents on a few other drugs are also going to expire soon. These drugs with pending patent expirations that are expected to reduce Eli Lilly's annual sales by about $7 billion from 2010 to 2014. As a result, Eli Lilly is currently trading at a low forward P/E ratio of 10.62, versus 16.25 for the average of the pharmaceutical industry. However, we think there are still better options than Eli Lilly. For example, another healthcare stock Pfizer Inc (NYSE:PFE) has an even lower forward P/E ratio of about 9. Pfizer also has a decent dividend yield of 4.1%. Pfizer's payout ratio is 63% and Eli Lilly's is 50%. But Pfizer has much stronger earnings growth than Eli Lilly. In fact, Eli Lilly's earnings are deteriorating. For the fourth quarter of 2011, Eli Lilly reported EPS of $0.77, versus $1.05 for the same quarter a year ago. According to Zacks, Eli Lilly's earnings are expected to decline by about 6% per year in the next couple of years, while Pfizer is expected to grow by about 4% annually. Therefore, Pfizer has the ability to maintain or even increase its dividend payouts in the near future.
Verizon Communications Inc is the second most popular high dividend stock among hedge funds tracked by us. At the end of last year, there were 27 hedge funds with Verizon positions in their 13F portfolios. They had around $600 million invested in this $108 billion market cap stock. Cliff Asness' AQR Capital Management had $67 million invested in Verizon.
Verizon has a high dividend yield of 5.17% and the company has been raising its dividend payouts for seven consecutive years. It recently increased its quarterly dividend from $0.4876 per share to $0.50 per share, which was paid to its shareholders in November last year. Verizon's payout ratio is a bit high though. Its current payout ratio is above 200%. The main reason for the high payout ratio is Verizon's poor earnings in the fourth quarter. It had a net loss of $2 billion. The total net income for 2011 is $2.4 billion, versus $2.5 billion for 2010 and $4.9 billion for 2009. Verizon kept increasing its dividend payouts while its earnings are deteriorating, leading to a high payout ratio. The poor performance in the fourth quarter also explains a high current P/E ratio of 45. However, analysts are optimistic about Verizon's future growth. The company is expected to grow rapidly in 2012, resulting in a low forward P/E ratio of 13.92. If Verizon grows as fast as expected, its payout ratio for 2012 will be lower than 80%.
We think Verizon's earnings growth is mainly dependent on how much its wireless margins expand. The company's wireline segment was relatively stable over the past year, thanks to the growth of Verizon FiOS. On the other hand, the growth in its wireless segment is slightly below analysts' estimates over the past year. It is very likely that the expansion of wireless margins will continue to be the theme for the year ahead. Verizon seems to be a bit overvalued compared with its main competitor AT&T Inc (T). Verizon's forward P/E ratio is 15% higher than the 12.10 for AT&T. We think AT&T is a better dividend play than Verizon. It also has a higher dividend yield of 5.73%. Moreover, in order to boost its wireless margins and earnings growth, AT&T has been increasing its price and pulling back on promotions, subsidies and upgrades. AT&T is also quite popular among hedge funds. Twenty-one hedge funds reported owning AT&T in their 13F portfolios at the end of last year, including Israel Englander's Millennium Management and Bill Miller's Legg Mason Capital Management.
A few other dividend stocks that hedge funds love include Exelon Corporation (EXC), Altria Group (MO), Reynolds American Inc (RAI), and CenturyLink Inc (CTL). At least 20 hedge funds reported owning these stocks in their 13F portfolios at the end of last year. We do not agree with these hedge funds on CenturyLink though. The stock seems to be overvalued compared with its peers. Domestic tobacco stocks also look a bit overvalued compared with the market. Strong investor demand for these reliable dividend payers has elevated stock prices considerably. These are still better alternatives than the 10-year Treasury bonds though.
Utility stocks also experienced a similar investor demand over the past year. Exelon's forward P/E ratio is slightly below 14. This is rich for a low growth stock that is facing significant competition because of cheap natural gas prices. Overall we prefer high dividend stocks with low forward PE ratios and mega-cap pharmaceuticals and telecom stocks generally fit the bill. Tobacco and utilities stocks may disappoint over the short-term though.