Do you think that the market rally is overdone? 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. 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 10, 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.
It is true that you can personally avoid taxation by owning the security in a tax deferred account but this serves as a benchmark. 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. 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, P/Es between zero and 20, and institutional holding percentage of at least 25 percent. While not a precise requirement, I prefer companies that have underperformed the S&P 500 in the last 52 weeks as it indicates limited downside relative to peers.
This is summarized below:
- Dividend Yield ≥ 4.0%
- Ex-Dividend Date = Next Week
- Market Capitalization ≥ $1B
- P/E Ratio: 0-20
- Institutional Ownership ≥ 10%
After applying this screen I arrived at the companies discussed below. 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. My goal is to present new companies to you and provide a brief overview of their recent developments and this should not be considered a substitute for your own due diligence.
Consider: Private Equity Companies
KKR Financial Holdings (KFN): 7.72% Yield - Ex-Dividend 3/13
KKR 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 KKR is depressed because it is a financial services company with a P/E below six. Furthermore, there is even more uproar surrounding private equity due to Republican Presidential candidate Mitt Romney and his high-profile work at Bain Capital.
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 since their ventures can fail but once they have successful investments, they can pay above-average dividends. The dividend was suspended in 2008 when the market crashed, but was reinstated in late 2009 and has been steadily rising ever since. As a limited partnership, there are special tax implications for this investment that also need to be considered on an individual basis with your tax consultant.
Since last quarter the dividend yield has declined approximately eighty basis points as the share price has improved. In the fourth quarter KKR issued $225M of senior notes at 8.375% to repay outstanding debts. Last month the company reported fourth-quarter EPS of $0.43, surpassing estimates by $0.06. KKR has traded in a tight range of $9.10 to $9.50 the last month as the only real news over that time frame is that KKR is partnering with Chesapeake in an oil and gas exploration venture.
Ares Capital Corporation (ARCC): 8.99% Yield - Ex-Dividend 3/13
Ares Capital Corporation is a specialty finance company that provides services to diverse middle-market companies that have unique financing needs. The underserved nature of the business makes this a highly lucrative segment but it is not without risk in this economic climate; however, with a P/E under nine I am comfortable with the margin of safety. Please note that ARCC is one of the largest Business Development Companies ("BDC") under the Investment Company Act of 1940. A nice overview of BDC is provided by IndieResearch but the primary point is that BDCs must distribute 90% of their earnings as dividends.
The dividend history is a little volatile but the dividend appears to be safe for at least the near-term. There are signs that ARCC is planning on growing for a potential acquisition as it has been raising a substantial amount of capital in the first quarter of 2012 (see "recent developments"). Q4 EPS came in at $0.48, beating estimates by $0.09.
Consider: Investment Services
NYSE Euronext (NYX): 4.13% Yield - Ex-Dividend 3/13
NYSE Euronext operates securities exchanges including the New York Stock Exchange (NYSE), NYSE Arca, NYSE Amex, and Euronext N.V. In February the European Commission blocked the proposed NYSE Euronext and Deutsche Borse merger which would have created one of the largest exchanges in the world. This would have been a substantial victory for NYSE but the company is still quite attractive at a 12 P/E. The uncertainty surrounding the merger was one of the major drags on the company and I believe it could start to rebound with the dark cloud removed. Sammy Pollack has a succinct summary of NYSE's prospects and highlights the value that the company has.
I do not look at NYSE Euronext as a traditional dividend play as the dividend appears elevated due to the slide in the share price but even at three percent I view it as a way to compensate investors while they wait for a recovery in value.
Avoid: Broadcasting & Cable TV
Shaw Communications (SJR): 4.76% Yield - Ex-Dividend 3/13
Shaw Communications engages in diversified entertainment offerings but focus primarily on Canadian cable television. Cable companies have traditionally been able to distribute sufficient cash flows to investors but the tides are starting to change with the rapidly rising cost of content. Factor in the popularity of internet connected television and other devices and I am not extremely bullish on the traditional entertainment content business model. I do not believe that investors are being adequately compensated for the level of risk assumed and the companies mentioned above offer comparable (or higher) yields for less risk. To summarize my stance, I would not feel comfortable owning companies in this industry long-term if I were forced to in a failed dividend capture.
Utility companies were the best performing sector in 2011 with fifteen percent returns as investors looked for a safe haven from the global economic turmoil. I have been investing in high yielding utilities such as Consolidated Edison (ED) for years for both income and capital appreciation. I wrote in-depth article on electrical utility dividends last week that should provide further color on the topic. I generally focus on earnings quality and geography to obtain insight into the companies for further research.
DTE services 3.3 million customers in twenty-four states but predominately focuses on Michigan. NWE services .7 million customers in Montana, South Dakota, and Nebraska. AEE also services 3.3 million customers in Missouri and Illinois. NWE has a healthier geographic region whereas DTE operates in an economically distressed area. Ameren appears to be a solid compromise between customer size and economic strength.
Consider: Pharmaceutical Companies
Merck & Co, Inc. (MRK): 4.49% Yield - Ex-Dividend 3/13
Merck is one of the largest pharmaceutical/biotechnology companies and is also one of the largest companies in the world with a market capitalization greater than $100B. Merck's core products include Cozaar (reduce risk of strokes), Fosamax (osteoporosis), Hyzaar (hypertension), Singulair (asthma), and Zocor (cholesterol). Both Vatalyst and Investment Underground recently highlighted Merck for its high quality dividends and overall financial strength. I have been long Merck for over one year as it has one of the better drug pipelines and highly respectable dividend while I wait.
Consider: Tobacco Companies
Altria Group (MO): 5.38% Yield - Ex-Dividend 3/13
Altria is one of the largest tobacco companies with major brands such as Marlboro and Virginia Slims. Tobacco companies make for great investments in all types of economies because tobacco users are always willing to buy the inelastic product. I have invested in both Altria (MO) and Philip Morris (PM) with tremendous capital gains and dividends over the years. The legal ruling against strong warning labels on cigarettes should benefit all companies in the industry. Tobacco companies are both mature and safe; precisely what investors are seeking in this economy. For this reason, I hold PM in my "Great Recession II" portfolio.
The information presented has been summarized below.
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