Many market observers believe that the stock market is likely to undergo a correction after the U.S. presidential elections. The slowing down of the U.S. economy, despite the recent improvement in the employment figures, and the deterioration in corporate earnings are exacerbating that risk. According to research (pdf) by Standards and Poor's, high-quality stocks, in principle, provide a cushion during market downturns and, in market volatility, pay a decent premium relative to returns of lower quality issuers.
High-quality stocks are those with sustained earnings power over a complete business cycle and decent dividend payouts over time. We focus on five high quality stocks that currently represent attractive income and value plays for cautious investors. All dividend stocks mentioned below have yields in excess of the yield on the 10-year Treasury bond or yields at or above the average yield on the S&P 500 index.
Altria Group (MO) is a $66-billion cigarettes maker, marketing such popular brands as Marlboro. Over the past five years, the company's EPS expanded at an average annual rate of 1.6% per year. Dividends, while having dropped in 2008, have been on a rise since 2010. Analysts forecast EPS growth averaging 6.4% per year for the next half decade. The stock has a ROE of 99%, and return on invested capital [ROIC] of 24%. Despite the negative sentiment due to harmful health effects and litigation, the company has strong brand power and the capacity to raise prices. On a forward P/E basis, the stock is priced slightly below its respective industry. It is yielding 5.3% on a payout ratio of 81%. Its competitors Lorillard (LO), Philip Morris International (PM) and Reynolds American (RAI) are yielding 5.4%, 3.7%, and 5.5%, respectively. Billionaires Ken Griffin and Stanley Druckenmiller are bullish about Altria Group.
The Chubb Corporation (CB) is a $21-billion provider of property and casualty insurance. Over the past five years, the insurance provider's EPS contracted at an average annual rate of 1.0% per year, while dividends grew at an average annual rate of 7.7%. The company's EPS is expected to grow at an average annual rate of 8.6% per year for the next five years. The stock has a free cash flow yield of 6.9%, ROE of 10.6%, and ROIC of 8.7%. Following years of weak top-line growth, the company has seen improving market conditions in recent quarters. The Chubb Corporation derives nearly a third of its revenues from abroad, and its strategy of international expansion in the markets with strong pricing trends will position it well for future growth. On a forward P/E basis, the stock is trading well below its respective industry. The company is a dividend aristocrat that has raised dividends every year since 1966. Currently, it is paying a dividend yield of 2.1% on a payout ratio of 28%. Its rival The Travelers Companies (TRV) is paying a dividend yield of 2.7%, while peer American Investment Group (AIG) is not paying any dividends. Fund manager Ric Dillon (Diamond Hill Capital-check out its top picks) and billionaire Ken Griffin are big fans of the stock.
Occidental Petroleum Corporation (OXY) is a $67-billion integrated oil and gas producer. Over the past five years, its EPS and dividends grew at 10.8% and 18% per year, respectively. EPS growth is forecast to average 9.9% per year for the next half decade. The company boasts a ROE of 17% and ROIC of 13%. It has strong financial position with expanding profit margins. Its balance sheet is solid with relatively low debt levels relative to equity. High oil prices bode well for this company. As regards valuation, on a forward P/E basis, the stock is priced below its respective industry. It is currently yielding 2.7% on a low payout ratio of 26%. Peers Exxon Mobile Corporation (XOM) and Royal Dutch Shell (RDS.A)/(RDS.B) pay dividend yields of 2.5% and 4.7%/5.3%, respectively. The stock is popular with value investor Ralph V. Whitworth (Relational Investors).
International Flavors & Fragrances (IFF) is a $5-billion producer of flavors and fragrances. Over the past five years, the company's EPS and dividends grew at average annual rates of 5.6% and 8.1% per year, respectively. Analysts forecast that IFF's EPS growth will accelerate to about 6.6% per year for the next five years. The stock boasts a free cash flow yield of 1.8%, ROE of 23%, and ROIC of 14%. The company's flavors division has seen strong growth, albeit the overall top- and bottom-line growth is restrained by an adverse foreign exchange effect. Lower input costs and higher margins bode well for bottom-line growth. The company pays a dividend yield of 2.2% on a payout ratio of 40%. For comparison, its rival Givaudan SA (GVDNY.PK) is yielding 2.4%. On a forward P/E basis, IFF's stock is attractive based on relative valuation as its shares are trading below the company's historical averages. The stock is up 15.8% year-to-date. Fund manager and billionaire D. E. Shaw holds a large stake in the company.
Johnson Controls Inc. (JCI) is an $18-billion company best known as the maker of heating, ventilating and air conditioning systems for cars (and residential buildings), building control systems, vehicle interior designs and systems. The company's EPS and dividends grew at average annual rates of 6.1% and 10.4%, respectively, over the past five years. Analysts forecast that its EPS will expand at an accelerated rate of 17.6% per year for the next five years. The company has a ROE of 15%, and ROIC of 10%. The rebound in vehicle sales in North America, and a resurgence of demand in the housing sector, bode well for the company's product sales. The company is expected to post better top-line growth relative to its peer group. The stock is well-position to capitalize on growth in emerging markets. The street is generally bullish about the stock. On a forward P/E basis, the stock is trading below its respective industry. It also has a price-to-book ratio below that of its peer group. Currently, the stock is paying a dividend yield of 2.8% on a low payout ratio of 29%. Its competitors Magna International (MGA) and Lear Corp. (LEA) are yielding 2.5% and 1.4%, respectively. Fund manager Sandy Nairn's Edinburgh Partners is the largest hedge fund investor in the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.