By David Russell

This week has seen an unusual amount of in-the-money option trading, which may reflect traders' response to the sideways market.

Below is the list of companies that will comprise Standard & Poor's Dividend Aristocrats after the close of business on December 18th. The changes that will be made to the list were detailed in an earlier post, Big Changes For Dividend Aristocrats Index in 2010.

There are certainly many ways to categorize the different styles of investing in dividend stocks, including yield, risk, growth, etc. An investment strategy based on any of these could be successful, if implemented within the framework well-crafted plan. Over the years, I have found that most dividend investing styles fall into one of the three major categories listed below:

High Yield/Low Growth

I would classify dividend stocks with a yield over 5% and dividend growth less than 2% in this group. This is probably the most popular group, particularly among those new to income investing. It is human nature to want it now and lots of it, and high yield stocks appear to deliver that desire. However, there is often a reason the stock’s yield is so high and many times the investor learns the hard way the yield is not always sustainable. Examples of stocks in the high yield/low growth group include:

The stock market has been on a consistent bull run since it hit a low in March 2009. As stocks keep hitting new highs for the year, driven by the prospect of economic recovery, many value investors are getting nervous about valuations. The P/E ratio on the S&P 500, for example, has risen to its highest levels in several years. In addition, many dividend stocks, which were once selling at very attractive valuations just a few months ago, are becoming expensive.

There are several ways that the market could correct itself. First, since the market is typically a strong indicator that predicts contractions and expansions in the economic cycle much better than most economists, the current upturn could be a forecaster of economic growth. This would lift earnings, decrease unemployment and bring valuations down to more reasonable levels, without causing any depression in stock market prices overall. If the market is ahead of itself however, it could stay flat for a period of time.

It seems it has been some time since I updated the performance of Standard & Poor's Dividend Aristocrats. Year to date through November 4, 2009, the Aristocrats have generated a better return than the Dow Jones Industrial Index, 12.2% versus 11.7%, respectively. However, the Aristocrats performance has trailed the return on the S & P 500 Index's return of 15.9%.

In the below table, I have shaded the rows for those companies that have cut their dividend this year.

• Aflac Incorporated (AFL) – Aflac also qualifies for the defensive investor. The company has had very stable earnings and earnings growth. In addition, the dividend yield is 2.50%, normalized earnings per share is $3.32, and P/E is 13.00. I currently value the company at $78. Insurance companies are – traditionally – solid investments when the price is down, and the market today seems to be redefining the concept of beating down financial/insurance companies. Aflac’s latest earnings release beat expectations and I believe the company still has a way to go back up.

• Chubb Corp (CB) – Chubb Corp, like the previous two companies, is suitable for the defensive investor. The company has a strong balance sheet and very strong stability. Another insurance company that seems to be a bit undervalued, Chubb has a dividend yield of 2.74%, normalized earnings per share of $5.42, and a P/E of 9.30. I currently value the company at a whopping $167 (based on the company’s great growth over the last 10 years) – a more “conservative” estimate based on only 3% annual growth comes to $79. In fact, based on the normalized earnings per share of $5.42, the market is currently implying only a 0.49% annual growth rate over the next 7-10 years. Surely that can be beat, given Chubb’s recent history of growth.

• E.I. du Pont de Nemours & Co. (DD) – DuPont does not qualify for the defensive investor based on a low current ratio (1.61), lack of strong enough earnings growth over the last 10 years, and a high price to book ratio. However, the company does pass the tests for the enterprising investor as the current ratio is over 1.5, and earnings have grown over the last 5 years. The dividend yield is a very appealing 4.97%, the normalized earnings per share is $2.41, leading to a P/E of 13.68. I value the company at $41. One of the most compelling traits of the company is the dividend. This week they declare the fourth quarter dividend of $0.41/share – the 421st consecutive quarterly dividend. Now that is dividend record stability!

• Entergy Corp (ETR) – Entergy Corp passes the tests for the defensive investor with flying colors. The only thing holding it back from a perfect score is the current ratio of only 1.18. The company yields a dividend of 3.00%, has a normalized earnings per share of $5.72, and a P/E ratio of 13.73 based on that normalized earnings per share. I value the company at $137. I believe the company is strongly suited to perform well over the long-term based on its efforts to grow its nuclear division. Entergy currently is the second largest producer of nuclear energy in the United States and is seeking to build more nuclear plants. Like American Electric Power Co, the company appears to have a good future ahead of it with the “green” movement.

Chubb Corporation (CB) third quarter earnings came in at $1.56 per share, ahead of the Zacks Consensus Estimate of $1.29 per share. Last year, the company reported earnings of 93 cents. The results were helped by a mild hurricane season, which overshadowed decline in premiums written.

Net income spiked to $596 million or $1.69 a share from $264 million, or 73 cents a share, in the year-ago period.

• Feinberg unveils pay cuts. So-called pay czar Kenneth Feinberg outlined much-awaited compensation rules for seven TARP recipient firms; top executives at firms such as Citigroup (C), AIG (AIG) and Bank of America (BAC) will have a pay cap of $500K - for many a 90%-plus reduction. Also, rather than cash, the rules require that the majority of salaries be paid in stock held for the long-term. The rules are only valid for two months - November and December - but will also form the basis for next year's reviews. Feinberg said the rulings are significant, and hopes his standards, which seek to strike a balance between compensation and risk-taking, will be "voluntarily picked up in the marketplace." In a brief statement, Treasury Secretary Tim Geithner said he hopes the new framework will encourage these companies to "return taxpayer dollars as soon as possible."
• Fed proposes compensation checks. While Feinberg was busy administering to TARP recipient firms, the Fed proposed a framework to crack down on pay packages that encourage bankers to take excessive risks by subjecting executives, traders and dealmakers' compensation to regulatory scrutiny. Instead of pay limits, the Fed's plan is to monitor pay practices at the nation's 28 biggest institutions, making sure compensation structures reward executives for long-term performance and discourage excessive risk-taking. Skeptics worry firms will continue to outsmart regulators in finding inventive ways to circumvent restrictions. (read the Fed's press release, proposal (.pdf), and Q&A (.pdf))
• Britain mired in recession. U.K. GDP dropped a surprising 0.4% in Q3, according to the Office for National Statistics, the sixth straight quarter of contraction. Economists had expected the British economy to move back to timid growth of 0.2%. Six quarters is the longest string of declines on record, while the 5.9% peak-to-trough drop in output is just short of the 6% contraction recorded in the recession of the early 1980s. The pound (ETF: FXB) fell like a stone following the report (-1% at 5:00 a.m.), retreating from a six-week high. (read ONS's preliminary GDP estimate (.pdf))
• CIT, Goldman near deal. After a week of tense negotiations, sources say CIT Group (CIT) and Goldman Sachs (GS) have reached an agreement over a $1B "make whole" payment CIT would owe Goldman if it files for bankruptcy, connected to a $3B credit facility Goldman extended it last year. The deal calls for Goldman to reduce the facility to just over $2B, and for CIT to pay Goldman $300M if it files for bankruptcy. An agreement opens the door for CIT to strike a deal with its bondholders, who were waiting on the outcome of the Goldman talks; it could also reduce CIT's need for financing from $6B to $4B.
• Nokia wants Apple to pay its dues. Nokia (NOK) filed a patent suit against Apple (AAPL) Thursday, claiming the iPhone violates 10 patents for GSM, UMTS and wireless LAN technologies. Nokia said it has repeatedly asked Apple to license its patents, which it developed as part of a consortium of global telecommunications companies, and says Apple is "attempting to get a free ride" on the back of its innovation. Cellphone royalties typically run at 1-2% of the wholesale price, estimated at $600 for the iPhone; a 2% royalty would put $12 per iPhone in Nokia's pockets.
• Book price-war under review. The American Booksellers Association asked the Department of Justice to investigate this week's book price-war between Amazon.com (AMZN), Wal-Mart (WMT) and Target (TGT), claiming it constitutes illegal predatory pricing that is damaging to the book industry and harmful to consumers. If the trio is allowed to continue selling hot-item books for under $10, the net result "will be the closing of many independent bookstores and a concentration of power in the book industry in a very few hands," it said. While mega-retailers can use book sales as a loss leader to drive traffic, independent bookstores rely almost entirely on profits from books. (read the ABA's letter to the DoJ)
• Amazon: emerging juggernaut. Amazon (AMZN) announced Q3 results that exceeded expectations, including a 28% jump in sales, and offered Q4 guidance that was well above analyst consensus, sending shares up over 14% in after-hours trade (see below). Electronics and other general merchandise (EGM) now accounts for 43% of Amazon's sales, vs. 54% for media. The rate of EGM growth (44%) versus that of media (17%) signifies the online retailer's rapid and successful transition from a bookseller to an "everything store," which will become even more pronounced once it completes acquiring Zappos in Q4. (read Amazon's Q3 earnings call transcript)
• Merck/Schering merger wins EC approval. The European Commission cleared Merck's (MRK) bid to buy Schering-Plough (SGP) in a deal worth more than $41B. "The proposed transaction would not significantly impede effective competition in the European economic area or any substantial part of it," the EC said. Merck agreed to sell its half of the Merial animal health business to Sanofi-Aventis (SNY), its JV partner, for $4B in order to meet antitrust requirements. The merged companies will cut 15% of their combined workforces.
• Fed's Evans warns of weak recovery: The Fed will be in no rush to withdraw fiscal stimulus, Chicago Fed president Charles Evans said yesterday, warning the recovery "is going to be very unsatisfactory in 2010." With weak labor markets and plenty of idle factory capacity, there is a sufficient slack in the economy to set aside inflation fears, he said. If anything, low levels of inflation are a concern.
• BP mulls rival bid for Jubilee. Sources say BP (BP) has hired Goldman Sachs (GS) to advise it on a rival bid to ExxonMobil's (XOM) $4B deal to purchase Kosmos Energy's stake in Ghana's Jubilee field. Goldman reportedly advised Cnooc (CEO) on a potential bid for the same stake. Cnooc's attempt is thought to have been hampered by its relative inexperience in developing such a large field, and Goldman's switch to advising BP implies a Cnooc bid is not forthcoming, analysts say.
• Sept. Leading Indicators: The Conference Board's Leading Indicators Index came in at +1%, vs. +0.6% in August and consensus of +0.8%. With the sixth consecutive increase, the six-month growth rate is now at the highest pace since 1983. The numbers suggest a strong recovery is developing, the group says, but notes "the continued downtrend in employment is keeping this index of current economic conditions from rising faster."

Earnings: Fri. Before Open

• Cache (CACH): Q3 EPS of -$0.43 misses by $0.23. Revenue of $44.9M (-22.7%) vs. $48.3M. (PR)
• Dover (DOV): Q3 EPS of $0.58 beats by $0.10. Revenue of $1.5B (-23.7%) in-line. (PR)
• Honeywell (HON): Q3 EPS of $0.76 beats by $0.04. Revenue of $7.7B (-17%) vs. $7.88B. (PR)
• Ingersoll-Rand (IR): Q3 EPS of $0.70 beats by $0.09. Revenue of $3.48B (-19.2%) vs. $3.56B. Sees 2010 EPS of $2.00-2.40 vs. consensus of $1.98. "The outlook for the strength and timing of the global economic recovery and the performance of our end markets remains cloudy. A preliminary review of our internal cost reduction and productivity improvement actions for next year gives us confidence that we can grow our earnings for 2010 even if our markets remain weak." (PR)
• Schlumberger (SLB): Q3 EPS of $0.65 beats by $0.02. Revenue of $5.43B (-25.2%) in-line. (PR)
• Whirlpool (WHR): Q3 EPS of $1.15 beats by $0.38. Revenue of $4.5B vs. $4.28B. Continues to see uncertain and volatile demand levels in many markets. (PR)

Earnings: Thur. After Close

• Amazon.com (AMZN): Q3 EPS of $0.45 beats by $0.12. Revenue of $5.5B (+28%) vs. $5B. Sees Q4 sales of $8.12B-9.12B vs. consensus of $8.11B. Shares +14.5% AH. (PR)
• American Express (AXP): Q3 EPS of $0.44 beats by $0.06. Revenue of $6B (-16%) vs. $5.9B. Consolidated provisions for losses down 13% to $1.2B. Tier one risk-based capital ratio 9.7%. Sees "broad-based improvements in credit quality" and encouraging trends in spending. Shares -0.5% AH. (PR)
• Broadcom (BRCM): Q3 EPS of $0.16 beats by $0.05. Revenue of $1.25B (-.35%) vs. $1.16B. Sees Q4 revenue flat sequentially. Shares -8.3% AH. (PR)
• Bucyrus International (BUCY): Q3 EPS of $1.21 beats by $0.35. Revenue of $676M (+5%) vs. $623M. (PR)CA Inc. (CA): FQ2 EPS of $0.42 beats by $0.02. Revenue of $1.07B (+1%) in-line. Shares +2.3% AH. (PR)
• Burlington Northern Santa Fe (BNI): Q3 EPS of $1.48 beats by $0.20. Revenue of $3.6B (-27%) in-line. Shares -1.9% AH. (PR)
• Capital One (COF): Q3 EPS of $0.94 beats by $0.80. Revenue of $$4.6B (+11.7%) vs. $4.11B. "We are successfully weathering the storm, but the storm is not over." Shares +8.5% AH. (PR)
• Cheesecake Factory (CAKE): Q3 EPS of $0.29 beats by $0.05. Revenue of $401M (-1%) vs. $397M. Comparable same-store sales down 2.8%. Shares +2.4% AH. (PR)
• Chubb (CB): Q3 EPS of $1.56 beats by $0.29. Total net written premiums of $2.7B (-7%). Raises full-year EPS guidance to $5.90-6.00 from $5.20-5.50, vs. $5.51. Shares -1.74% AH. (PR)
• Compuware (CPWR): FQ2 EPS of $0.12 beats by $0.04. Revenue of $218M (-19%) vs. $201M (one estimate). Shares +5.3% AH. (PR)
• Developers Diversified Realty (DDR): Q3 FFO of $0.44 beats by $0.01. Revenue of $202M (-9%) vs. $194M. Shares +1.1% AH. (PR)
• Eastman Chemical Company (EMN): Q3 EPS of $1.38 beats by $0.25. Revenue of $1.3B (-27%) in-line. Sees Q4 EPS of $0.85 vs. $0.79. Shares +3.2% AH. (PR)
• Emulex (ELX): FQ1 EPS of $0.08 beats by $0.02. Revenue of $86M (-23%) vs. $81M. Sees Q2 revenues of $88M-92M vs. $87M. Shares +2% AH. (PR)
• Informatica (INFA): Q3 EPS of $0.22 beats by $0.02. Revenue of $123M (+8%) vs. $120M. Shares -2.1% AH. (PR)
• Interactive Brokers (IBKR): Q3 EPS of $0.20 misses by $0.11. Revenue of $272M (-45.3%) vs. $298M. Market making income -47% Q/Q and -74% Y/Y due to tighter bid/offer spreads on options. Shares -7.2% AH. (PR)
• Juniper Networks (JNPR): Q3 EPS of $0.23 beats by $0.03. Revenue of $824M (-13%) vs. $797M. Shares +1.6% AH. (PR)
• Lattice Semiconductor (LSCC): Q3 EPS of $0.00 beats by $0.02. Revenue of $49M (-15%) vs. $47M. Shares +5.6% AH. (PR)
• Leggett & Platt (LEG): Q3 EPS of $0.34 beats by $0.06. Revenue of $810M (-28%) vs. $840M. Raises full-year EPS guidance to $0.65-0.75 from $0.55-0.70, vs. $0.64. Shares +0.5% AH. (PR)
• MEMC Electronic Materials (WFR): Q3 EPS of -$0.29 misses by $0.23. Revenue of $310M (-43%) vs. $302M. Shares -3.8% AH. (PR)
• Netflix (NFLX): Q3 EPS of $0.52 beats by $0.06. Revenue of $423M (+3.6%) vs. $420M. Subscriber acquisition cost $26.86 per addition vs. $32.21 a year ago. Churn was 4.4% vs. 4.2% a year ago. Shares -3.3% AH. (PR)
• PMC Sierra (PMCS): Q3 EPS of $0.15 beats by $0.01. Revenue of $131M (-6%) in-line. Shares -0.6% AH. (PR)
• Rambus (RMBS): Q3 EPS of -$0.26 misses by $-0.02. Revenue of $28M (-5%) vs. $27.6M (one estimate). Shares -0.3% AH. (PR)
• Riverbed Technology (RVBD): Q3 EPS of $0.19 beats by $0.04. Revenue of $103M (+18%) vs. $97M. Shares +0.8% AH. (PR)
• Sunpower (SPWRA): Q3 EPS of $0.42 beats by $0.02. Revenue of $466M (+23%) vs. $420M. Shares -11.4% AH. (PR)
• Synaptics (SYNA): FQ1 EPS of $0.48 beats by $0.06. Revenue of $120M (+3%) vs. $116M. Expects Q2 revenue of $128M-134M vs. $137M. Shares +10.1% AH. (PR)
• Synovus Financial (SNV): Q3 EPS of -$1.27 misses by $0.60. Net interest income of $758M (-8%). Shares -7.6% AH. (PR)
• Western Digital (WDC): FQ1 EPS of $1.25 beats by $0.31. Revenue of $2.2B (+4.3%) vs. $2.06B. Says demand remains strong. Shares +1.3% AH. (PR)

Today's Markets

Overseas markets echoed U.S. gains Friday. Futures are marginally higher in light overnight action.

Q3 2009 Earnings Call

October 22, 2009 05:00 PM ET

I am a firm believer in keeping things simple. However, you can simplify things to the point they no longer have value. In my opinion, a lot of the commonly used financial metrics can be very misleading unless you understand what is behind them. I would put EBIT, EBITDA and Dividend Payout in this category. As an investor in dividend stocks, I see Dividend Payout used a lot, so let’s take a closer look at it.

Most companies use debt for a variety of reasons in their operations. It could be either short term or long-term obligations. If there’s anything the 2007-2009 financial crisis has taught us, it is that excessively leveraged companies could easily blow up after a chain of negative events. Thus it pays to know what the debt situation for a particular company you are investing in actually is.

Some investors typically focus on debt to total assets to gain a perspective on the amount of the leverage the company has. While this method is widely accepted by some investors, I believe that it has some shortcomings, which might prevent investors from seeing the bigger picture. Most importantly comparing debt to total assets does not tell whether a company could service its debt obligations or not.

One of the larger holdings in the Against the Sky Portfolio is Markel (NYSE: MKL), a specialty property and casualty insurer. Before the market decline, Markel had built an impressive track record of both underwriting profits and investment returns. With some stability returning to the market, Markel may be poised to return to its historic price to book value. This would result in some very nice gains for Markel investors.

About the Company

Markel competes in three areas of specialty insurance. These are Markel's Excess and Surplus Lines, Specialty Admitted, and the London Insurance Market. The Excess and Surplus Lines writes property and casualty insurance for nonstandard and and difficult to place risks. Markel's Specialty Admitted line also writes more unique and specialty insurance where the customer requires an admitted insurance company. The London Insurance line also writes specialty property, casualty, marine, and aviation insurance and reinsurance.

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, (published Monday September 28th):

Zebras have the same problem as institutional portfolio managers. First, both seek profits. For portfolio managers, above average performance; for zebras, fresh grass. Secondly, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions. Third, both move in herds. They look alike, think alike and stick close together.

Financial stocks, which used to be great dividend investments, have had their share of troubles over the past two years. The sector has rebounded sharply since hitting its lows in March. Since the major dividend growth stories of the past such as Bank of America (BAC) and US Bancorp (USB) have cut dividends, most dividend growth investors seem to have a very low allocation to the sector. As a result dividend investors could suffer inferior risk adjusted returns in the future since they won't own any financial stocks.

There are several alternatives for investors who are underweight the financial sector right now. One of them involves purchasing shares in some of US insurance companies such as Aflac (AFL) or Chubb (CB), which offer decent yields and have a long history of dependable dividend growth.

The financial crisis has been tough not only for stock prices but also for dividends as well. Some former dividend darlings in the financial sector have seen their dividends being cut or eliminated after taking in billions in TARP aid due to severe losses from complex financial instruments. As a result the ratio of dividend increases to dividend cutters has been hovering at almost even for both. This means that so far in 2009, there is roughly one dividend cutter for every dividend raiser. Over the past 5 years this ratio has been more like 6 to 1 in favor of the dividend growers.

Due to the horrifying statistics of the overall bleak dividend picture, some reporters are claiming that dividend investing is dead. Just because you read it in the paper however, doesn’t mean it is true for everybody. While the overall statistics have been rather scary, the negative dividend news has been concentrated in the financial sector. Thus a well- diversified portfolio of income stocks should have performed well even during crisis.

The Chubb Corporation (CB), through its subsidiaries, provides property and casualty insurance to businesses and individuals. The company operates through three segments: Personal Insurance, Commercial Insurance, and Specialty Insurance. The company is member of the S&P 500 and the S&P Dividend Aristocrats indexes.

Chubb has consistently increased dividends every year for 44 years. The company announced a 6.10% dividend raise in February 2009, plus a 20 million share repurchase initiative in December 2008.