By Lisa Springer
Equity markets are eking out weak gains this year, causing savvy investors to load up on dividend stocks as a way to boost returns. Also adding to the appeal of dividend stocks right now is the unusually large spread between dividend and bond yields -- the largest in nearly half a century.
The efforts of the Federal Reserve to keep interest rates low have allowed investors to get better yields from a stock's dividend than from that same company's corporate bond.
Here are four high-quality stocks that have especially wide spreads between their dividend and bond yields. Their low bond yields indicate that lenders think these companies are safe. In addition, three of the four stocks are
Dividend Aristocrats boasting 25 or more years of dividend increases, each with a solid balance sheet and impressive cash flow.
1. Diamond Offshore Drilling (DO)
Corporate bond yield: 2.2%
Diamond Offshore is a global offshore oil and gas drilling contractor specializing in deep-water projects. The company's fleet consists of 36 deep-water rigs, 12 jack-up rigs and four ultradeep water drillships under construction. Diamond Offshore began 2012 with a $8.6 billion contract backlog and more than 80% of its fleet committed under long-term contracts.
Although higher rig maintenance costs caused earnings per share (EPS) to fall 26% to $1.33 in the first quarter of 2012 compared with a year earlier, Diamond Offshore is set to benefit, later this year, from upgrades to its fleet and deployment of new deep-water rigs that command premium day rates.
Diamond Offshore has nearly enough cash ($1.4 billion) to cover all of its debt ($1.5 billion) and the company generates $1.4 billion of annual cash flow. Moody's recently upgraded the company's credit rating to "A3," citing Diamond Offshore's low debt relative to industry peers and strong market position.
The company has a two-tiered dividend structure consisting of a regular $0.50 annual dividend paid since 2005, and a special dividend paid every year since 2006. Last year, the special dividend totaled $3.00. When you combine both dividends, you obtain a yield of roughly 5.0% -- twice this company's 2.2% corporate bond yield.
2. Pfizer (PFE)
Corporate bond yield: 2.4%
Pfizer is the world's largest pharmaceutical maker. The company markets 18 major drugs that together generate more than $26 billion in annual revenue, including Lipitor (cholesterol), Zoloft (depression), Norvasc (heart disease), Celebrex (arthritis) and Lyrica (fibromyalgia).
The loss of patent protection on Lipitor was the main reason for a 14% decline in first-quarter earnings per share to $0.24 this year from the year-ago period. Pfizer expects to offset declining Lipitor sales through the launch of new drug treatments such as Prevnar (a vaccine for pneumonia), Inlyta (for cancer) and Eliquis (for stroke prevention).
The company also plans to sell its infant formula business to Nestle for $11.9 billion and use the proceeds to buy back shares. Next year, Pfizer plans to sell a stake in its $4 billion animal health business through an initial public offering.
Pfizer has a 30-year record of paying dividends and raised payout every year until 2009, when the dividend was cut in half to pay for the Wyeth acquisition. Since then, growth has been steady, including a 10% increase in February to a $0.88 annual rate yielding almost 4.0%. Pfizer's corporate bonds yield on average just 2.4%.
3. Nucor Corp. (NUE)
Corporate bond yield: 2.2%
Nucor Corp. is a North American steelmaker and arguably the most efficient in the industry. The company operates mini-mills that are able to ramp production up or down quickly, depending on market conditions. Nucor is also a recycler, using scrap steel as feedstock for production. By minimizing the effects of raw materials price increases, Nucor can stay profitable, even when competitors are losing money.
Weaker steel prices were the main reason for an 8% decline in first-quarter earnings of $0.46 per share this year from the year-ago period. But Nucor is seeing gradual improvement in automotive, energy and heavy equipment markets, so analysts say this company could deliver 72% earnings growth next year.
During the down cycle, Nucor invested $5 billion in mill expansion projects and acquisitions, which analysts predict could drive 9% annual growth for the next five years.
Nucor is the only major steelmaker with an "A/A2" credit rating. The company has increased its dividend 39 years in a row and grown its base dividend 10-fold in the past decade. Nucor shares yield nearly 4.0%, or nearly twice the company's 2.2% corporate bond yield.
4. Phillip Morris International (NYSE: PM)
Corporate bond yield: 2.4%
This leading international tobacco company owns seven of the world's top 15 brands, including Marlboro, the top-selling cigarette brand worldwide. Phillip Morris sells tobacco products in 180 countries and holds a 16% share of the international cigarette market outside of the United States.
Increased shipments to emerging markets fueled 18% growth in first quarter earnings per share to $1.25 in 2012 compared with the same quarter in 2011. Phillip Morris is committed to generating 10-12% yearly earnings growth, which will be achieved through a combination of new products, increased advertising and aggressive share repurchases.
The company is a cash machine that has generated $10 billion of cash flow in the past 12 months and earns an "A2" debt from Moody's. Philip Morris has increased its dividend every year since its 2008 spin-off from Altria Group (NYSE: MO), including a 20% increase in September to a $3.08 annual rate. The share yield of almost 3.5% is much higher than the 2.4% yield on Phillip Morris corporate bonds.
Risks to consider: The steel industry is extremely cyclical and Nucor's earnings fall during down cycles. Roughly 25% of Philip Morris' sales are from Europe, which gives this stock exposure to currency swings and a weak European economy.
My top pick overall is Nucor. As a result of investing during the downturn, Nucor is positioned for rapid revenue growth when its end markets recover. An added incentive for Nucor shareholders is a supplemental dividend the company pays during good years, which has amounted to as much as $1.81. Having said that, all four of these stocks pay safe, high dividends and owning all four creates a well-diversified portfolio.