Thanks to the low-interest rate policy of the Federal Reserve, income investors have been bidding up dividend stocks for the past couple of years. Dividend stocks are one of the only places where investors can earn a respectable yield, because certificates of deposits, savings accounts and money market rates are so low, that they are competing with the rates offered by hiding money under your mattress.
Some even believe that a bubble is building with certain dividend stocks. While valuations are not in the bubble-zone for most dividend stocks, the sector could certainly see a correction, especially if an outside catalyst makes dividend stocks far less attractive. That catalyst for a stock market correction could be President Obama's 2013 budget, which is poised to drastically change after-tax returns for dividend stocks. A recent Wall Street Journal article outlines the risks and states:
"President Obama's 2013 budget is the gift that keeps on giving-to government. One buried surprise is his proposal to triple the tax rate on corporate dividends, which believe it or not is higher than in his previous budgets. Mr. Obama is proposing to raise the dividend tax rate to the higher personal income tax rate of 39.6% that will kick in next year. Add in the planned phase-out of deductions and exemptions, and the rate hits 41%. Then add the 3.8% investment tax surcharge in ObamaCare, and the new dividend tax rate in 2013 would be 44.8%-nearly three times today's 15% rate."
Of course, this budget could be changed, especially if President Obama loses the upcoming election. However, there is a real risk involved, so investors should start planning now. President Obama has a very good chance of being re-elected, and since the markets look ahead, we could see a major correction in dividend stocks well before the 2013 budget is implemented.
A dividend stock correction would probably lead to a general market correction and that's why it could make sense for some investors to lighten up on positions now. Cash-rich investors are likely to find much better entry points in their favorite stocks later this year. A drop of 5% to 15% is possible for many of these stocks, and while that may not seem like a lot, it could take five years for a stock yielding 3% to make up a loss of roughly 15%. With this in mind, here are a number of solid dividend stocks that would be worth considering after a correction:
Johnson & Johnson
Johnson & Johnson (NYSE:JNJ) owns many famous consumer brands such as Listerine, Motrin, Band-aid, Reach, Splenda, Tylenol, Lubriderm, Sudafed, etc. These well-known brands and products like pain relievers, lotions, etc., are always going to be steady selling items. This makes the stock a lower-risk investment since these items sell in good times or bad, plus, technology is not likely to make Reach mouthwash or Tylenol obsolete.
Johnson & Johnson stock sells at a reasonable price to earnings ratio of about 12. This company has a strong history of raising the dividend. Thanks to consistent increases, the dividend has jumped from $1.10 per share in 2005, to $2.28 per share in 2012. This stock has been fairly steady over the past year, but it has been rising with the markets. It could pullback to about $60 per share, which is close to the 52-week low, in the event of a dividend or general market correction. That would be a more ideal time to consider buying this stock for the long-term.
Key points for JNJ:
Current share price: $65.12
The 52-week range is $58.50 to $68.05
Earnings estimates for 2012: $5.11
Earnings estimates for 2013: $5.44
Annual dividend: $2.28 per share which yields 3.5%
Verizon (NYSE:VZ) offers communication services such as Internet access, broadband data, long distance, etc. Verizon has been a top pick for dividend investors for the past few years, and the stock has been pushed higher and higher. It now trades very close to the 52-week high and that has pushed the yield down to just about 5%. This company has a lot going for it and it is benefiting from the popularity of the iPhone; however, the stock looks overextended for now.
Verizon could drop considerably in a correction. Its shares trade for about 16 times earnings. The average stock in the S&P 500 Index trades for just over 12 times earnings. This means Verizon shares are about 40% more expensive when compared to the averages. Furthermore, the dividend payout eats up about 80% of estimated earnings. This is high when compared to some other dividend stocks and it means that the dividend might not have much room to rise in the future. Verizon stock could see a more than average decline due to the risks investors are taking by paying a large premium for a stock that has a high dividend to earnings ratio. I would only consider Verizon shares at about $34.50 or less.
Key points for VZ:
Current share price: $39.57
The 52 week range is $32.28 to $40.48
Earnings estimates for 2012: $2.49 per share
Earnings estimates for 2013: $2.58 per share
Annual dividend: $2 per share which yields 5.1%
Bristol-Myers Squibb (NYSE:BMY) is leading pharmaceutical company with a broad pipeline, which includes drugs such as Plavix and Abilify. This stock has already pulled back from the 52-week high, but it still could see additional downside in a dividend stock or general market correction. These shares trade for almost 17 times earnings and that is a significant premium to the S&P 500 Index, and to other major drug makers. Also, the dividend payout is high when compared to earnings. This could mean that dividend growth will be limited in the future. This stock traded below $30 per share in December, and it would not be surprising to see that level tested again later this year.
Key points for BMY:
Current share price: $33.18
The 52 week range is $25.69 to $35.44
Earnings estimates for 2012: $1.97 per share
Earnings estimates for 2013: $1.94 per share
Annual dividend: $1.36 per share which yields 4.1%
Merck and Company
Merck and Company, Inc. (NYSE:MRK) is a major pharmaceutical company that develops and manufactures vaccines as well as a number of consumer health products. Like many drug companies, Merck is working to develop new products and treatments in order to counter revenues lost from patent expirations. Earnings are expected to drop only slightly in 2013, and this stock looks more reasonably valued when compared to other companies in this sector.
For example, Merck trades at just about 10 times earnings versus nearly 17 for Bristol-Myers. Also, Merck's dividend payout takes up a much smaller portion of its earnings estimates. Currently, the dividend is less than half of projected earnings, which means there is significant room for future dividend increases. Merck shares probably have less downside risk in a correction and buying dips to about $35 or less could reward long-term investors.
Key points for MRK:
Current share price: $38.03
The 52 week range is $29.47 to $39.43
Earnings estimates for 2012: $3.79 per share
Earnings estimates for 2013: $3.72 per share
Annual dividend: $1.68 per share which yields 4.4%
Philip Morris International
Philip Morris International (NYSE:PM) owns many well-known cigarette and tobacco brands, which include Marlboro, Merit, Parliament, Virginia Slims, L&M, and Chesterfield. Investors like the stable source of revenues and profits that this company offers; however, this stock is trading close to the 52-week high and looks vulnerable to a correction.
The dividend takes up about 60% of earnings, so that is not a major concern. What investors should consider is that this stock was trading for just about 12 times earnings, when it was near the 52-week low of about $60. However, investors have bid up this stock, so that it now trades for around 16 times earnings. This is well above the S&P 500 Index average of just over 12 times earnings.
If dividends are taxed at much higher levels, it would be particularly hard to justify paying such a large premium for this stock. The shares traded for about $73 just a few weeks ago, and the stock could be headed back to that level later this year.
Key points for PM:
Current share price: $85.81
The 52 week range is $60.45 to $86.17
Earnings estimates for 2012: $5.32 per share
Earnings estimates for 2013: $5.90 per share
Annual dividend: $3.08 per share which yields 3.6%
The Coca-Cola Company
The Coca-Cola Company (NYSE:KO) is a great stock to own for the long term because it owns so many popular brands such as Sprite, Vitamin Water, Minute Maid Orange Juice, Dasani, and more. However, the stock has been pushed higher by dividend investors and it now looks too expensive.
Coca-Cola shares are near the 52-week highs now and trade well above the market average in terms of price to earnings ratio. Investor demand for this stock has pushed the price to earnings ratio to about 17, and the yield has fallen below 3%. Investors are right to buy this stock for their portfolios, but what they pay is important. This stock was trading for about $64 in late November, and these share are worth buying around that level, or less in a correction.
Key points for KO:
Current share price: $70.16
The 52 week range is $63.05 to $71.77
Earnings estimates for 2012: $4.08 per share
Earnings estimates for 2013: $4.47 per share
Annual dividend: $2.04 per share which yields 2.9%
Data is sourced from Yahoo Finance.
Disclaimer: No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.