The Search For Safe 4% Dividend Yields

Includes: COP, JNJ, KMB, KO, LMT, MCD, NKE
by: Tim McAleenan Jr.

I just finished reading an article in Smart Money by Jack Hough titled "For Safe, 4% Dividends, Look Here." The general recommendation of the article advocated focusing on international companies and mutual funds that offered current dividend yields over 4%. For the interview, Hough talked with Brad Kinkelaar, who is one of the co-managers of the Pimco Dividend Fund. After suggesting a host of international and mutual fund sources of 4% current yields, Kinkelaar took a moment to discuss the Pimco Dividend Fund with Hough:

"A small number of actively managed mutual funds invest in dividend-paying stocks world-wide (including in the U.S.), but most haven't been open long enough to compare performance records, says Christopher Davis, a fund analyst at Morningstar.

Mr. Kinkelaar's fund, Pimco EqS Dividend, carries a dividend yield of about 4% and holds stocks that trade at an average of 10.6 times earnings estimates, versus 12.2 times for the "world stock' category, according to Morningstar. Allianz NFJ Global Dividend Value,which launched in June 2009, yields 4.4% and carries an average price/earnings ratio of 8.7.But both funds have maximum upfront sales charges of 5.5%, with discounts for large purchases."

The line that caused my eyes to bug out was this: both funds have maximum upfront sales charges of 5.5%. As someone concerned with avoiding permanent capital impairment, I can't imagine taking a 5.5% hit just out of the gate. If you pay a 5.5% fee upfront on $1,000 invested, you need a 5.85% return to just get back even to the $1,000 that you're investing. This is especially egregious within the context of a dividend fund, where success and progress is often measured by incremental gains in income generated. Paying a sales charge of 5.5% for a dividend yield of about 4% sounds like a disastrous dividend strategy.

One thing that surprised me in Hough's article is that he did not recommend large US multinational companies as candidates for "safe 4% dividends." As American investors, one of our best advantages is that many firms incorporated in America during the post-WWII decades established themselves as truly global leaders, with firms like Coca-Cola (NYSE:KO), Nike (NYSE:NKE), and McDonald's (NYSE:MCD) each generating profits in 100+ countries. Sure, they're domestically headquartered-but they're global in operational scope. And this comes with the added benefit of regular quarterly dividend benefits that are not subject to any additional tax.

If your goal is to find safe 4% dividend yields, there are plenty of mega-cap American companies that currently offer yields suitable for meeting that objective. Johnson & Johnson (NYSE:JNJ), at a 3.93% yield, is just on the cusp of yielding 4%. Conoco Phillips (NYSE:COP) yields just shy of 5%. And Lockheed Martin (NYSE:LMT) at 4.85% is another high-yielding option.

One of Hough's international recommendations for those searching for safe 4% yields was a Brazilian water company. For all I know, it can very well turn out to be an excellent stock selection. But it does illustrate an impulse that I try to fight. For many, there is an urge to try to make a portfolio more glamorous. It just sounds more fun to own some undervalued small-cap Chinese tech company instead of a company like Kimberly-Clark (NYSE:KMB) that sells diapers and Kleenex. While there's a time and place for trying to be sexy, I don't think a stock portfolio is it. If I want to find safe 4% yields, I'm going to ignore the international companies and funds mentioned in the Hough article. I'll take my chances with the mega-cap US nationals like J&J and Conoco that appear to not only offer a safe 4%-ish yield, but appear likely to turn that yield into much more several decades from now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.