By Shane Sokol
It's time to forget about Treasuries as an investment or a place to store money. As the Federal Reserve holds interest rates down, yields that one can expect even from long-term Treasury notes are miniscule. The longer 10-Year US Treasury note is paying just 1.48% this week. Since inflation is taking 2.49% away from you at the same time, parking your money with the government is a losing proposition. What you want are not just higher yields, but monster yields.
Professional investors such as hedge fund managers are paid handsomely and are expected to find ways to turn average returns into monsters. An excellent way to peek into their playbook and see where these experts are turning for monster returns is to read through tedious 13F filings.
Billions of dollars have been moved into dividend-paying, high quality stocks by investment gurus. In fact, the S&P 500 basket of stocks is currently yielding 2.14%, well above Treasuries, and more than half of all stocks in the S&P 500 index yield more than the Treasury note. We think high dividend stocks will significantly outperform the long-term Treasuries over the next 10 years. A good place to look for dividend stocks is hedge funds' portfolio. Here are five dividend kings that the hedge fund managers agree on.
- American Capital Agency Corporation (AGNC): American Capital operates as a real estate investment trust (REIT), an investment company that deals exclusively in real estate and mortgages. It invests in residential securities as well as government or government agency-guaranteed securities. With profit margins above 90%, one would expect large yields. American Capital's yields are so large that it is one of the most loved of all monster dividend stocks, those that yield 5% or more. It currently owns the largest yield on this list, a whopping 15.4% at current prices. There is one more number that will impress further. The company's price-to-earnings ratio is a paltry 5.1, well below its peers, indicating it might be undervalued. We are not the only ones impressed with American Capital, as 24 hedge funds tracked are shareholders. The largest holding by any of the funds belongs to Pine River Capital Management with 7.4 million shares.
- Annaly Capital Management, Inc. (NLY): Annaly is also classified as a REIT, investing in mortgage pass-through certificates, debentures and other mortgage-related vehicles. It enjoys a high profit margin topping 63% and is benefiting from the current economic climate. The Federal Reserve Bank has held down interest rates allowing Annaly and other REITs like Boston Properties, Inc. (BXP) and General Growth Properties (GGP) to deploy capital at a lower cost. The lower the rates are, the larger Annaly's profit margins grow. Annaly should always be at the top of anyone's REIT shopping list due to their style and approach to investing. The company employs leverage very conservatively, never using all of its capacity in any one financing option. This means it usually has more flexibility in negotiations and tend to have more cash on hand than other potential buyers. Cash can be used in almost any situation, an advantage in speed and an advantage in negotiating for favorable terms. This advantage that other funds just do not have gives us the opinion that Annaly is one of the "best of breed" and worthy of consideration as an investment, yielding 13.3% at current prices. There were 25 hedge funds with bullish positions in Annaly at the end of March.
- Vale S.A. (VALE): Based in Brazil, Vale is the second-largest metals and mining firm in the world. Its largest competitors include Rio Tinto plc (RIO) and the massive BHP Billiton Limited (BHP). Vale is involved in a myriad range of other business segments, including basic materials like steel, bulk materials like iron ore, transportation and even aluminum trading. The variety keeps market risks in check. The company boasts expanding profit margins and solid financial footing with reasonable debt levels. After a few quarters in which Vale missed earnings expectations, the stock has fallen, nearly cut in half before rebounding slightly. Expectations are for the company to continue righting the ship. Vale paid a special dividend last August, in excess of the standard dividends payable in April and October. The company has a history of paying special dividends - four of the past six years. Quite a few investment gurus believe management has what it takes since 25 hedge funds hold a position in the company, an increase of 14% over the prior quarter. For monster yields of 6.1% (9.1% including the special dividend payment made in August) and a bright future, Vale should be considered a worthy turn around play with a dividend paying bonus.
- Vodafone Group plc (VOD): Vodafone provides mobile phone services to approximately 370 million people worldwide, data services to millions more and wholesale carrier services to dozens of African countries. While the stock is almost unchanged from the beginning of the year, a Sunday Times story reports that the company may receive a dividend from Verizon Communications (VZ) worth $4.5 billion. Vodafone would likely pass that along to shareholders. It is likely more investment funds and companies will increase their ownership in anticipation of the special dividend payment. That rush to buy shares could push the stock higher, benefiting shareholders in capital gains as well as dividend income. So far, there has not been a dramatic increase in hedge fund ownership that can be perceived yet. Because hedge funds report holdings after the fact, there is a delay in obtaining shifts in holdings. We may see increases after the next reporting period data is released. The chance to capture a large dividend before the price of the security moves to compensate is an opportunity worth exploring. A total of 4.96 billion shares outstanding means each share held will be eligible to pay a special dividend of up to $0.90 per share. Even discounting the idea of a special dividend, Vodafone yields 7.4%, paying $2.138 over the previous year.
- Avon Products, Inc. (AVP): This household name began selling perfume in 1886 and grew into an important source of income for countless women when opportunities were fewer. The company, through shares of its stock, also provides income to investors. A rough 2011 saw Avon shares lose about half of their value - from a high of $28.96 to $14.89. The pain has subsided as strong revenue growth outlook has warranted an upgrade. Deutsche Bank has stated that Avon's product mix has strong potential and the bank raised its target for the stock to $23. Hedge fund managers have followed suit with eleven funds initiating new positions in the most recent reporting period. One of those new investors is Perry Capital who purchased 5.5 million shares. Richard Perry manages the fund and is known for being an activist investor to promote changes that will unlock value for shareholders. However, he usually avoids management teams that are uncooperative. It's possible he's found a willing partner in Avon - a partner open to suggestions that will increase share prices. We believe that the short-term horizon is challenging, but the worst is over. The shares are undervalued and a return to glory is in the works. A loss in the December 30, 2011 quarter has already been reversed and Avon posted net income of $26.5 million for the quarter ended March 2012. The decline in share price provides us with a monster yield opportunity of 5.6%.
Disclosure: I am long VOD.