Dividends May Not Be Sexy, But They Pay

by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (August 3rd):

Observers of our work know that we have always emphasized the importance of dividends with regards to their impact on total portfolio returns. Manifestly, since 1926 dividends have accounted for more than 40% of the S&P 500’s annual return. Further, dividend-paying stocks, if those dividends are secure, tend to become more valuable as their share price declines because the dividend yield increases. Therefore, when we can find a “yield play” to take advantage of an intriguing investment, it always piques our interest.

Most recent case in point, Whiting Petroleum (NYSE:WLL) where we recommended Whiting’s (then 6.7%-yielding) convertible preferred “A” shares some five weeks ago. Those convertible shares now yield 5%. In keeping with this dividend theme, today we share some more yield-oriented ideas from Raymond James’ favorably rated universe of securities. To wit, as written by our convertible desk analyst, Brian Heck:

1) “My favorite short-term, yield-to-put favorite is still NII Holdings’ (NASDAQ:NIHD) 2.75% bonds. At $97.00, they have a 5.79% yield to the 08/15/10 put. The company has ~$1.25 billion in cash on the balance sheet and no debt maturities before the put. They are unrated and should only be considered for clients where this is suitable. This is purely a fixed income play and likely to be unaffected by any moves in the common. Another good name, for investors looking for a higher-rated security, would be the A1/AA Medtronic’s (NYSE:MDT) 1.625%. At $97.875 they have a 2.227% yield-to-maturity [YTM] with a ~55% conversion premium. Although it’s a pretty modest YTM, you do maintain upside exposure to the common shares.

2) Some of my favorite hybrid / total return picks would be Micron’s (NASDAQ:MU) 1.875%, Lifepoint’s (NASDAQ:LPNT) 3.50%, Old Republic’s (NYSE:ORI) 8.00%, and ON Semiconductor’s (ONNN) 2.625%. All four of these bonds mature in less than five years, or are puttable in the case of ONNN. With the exception of ORI, they all have 250-400 bp yield advantage over the common (~275 for ONNN, ~400 for LPNT, ~265 for MU). Conversion premiums are all under 75% (~40% for ONNN, ~25% for ORI, ~60% for LPNT, ~65% for MU). These names should all demonstrate adequate equity-sensitivity, but should also hold up well should equity markets falter.

3) One other, more equity-sensitive, name that I like is Jet Blue’s (NASDAQ:JBLU) 6.75%. The JBLU 6.75%s should be seriously considered for any investor eyeing JBLU common stock. Please don’t summarily dismiss the bonds because they trade at $120-125 (with stock in $5.11 area). These are NOT to be confused with normal straight debt instruments. This bond is an excellent EQUITY ALTERNATIVE offering a ~5.25+% current yield and only a ~20% conversion premium. They have a very high equity-sensitivity, due to the small conversion premium, and offer greater downside protection should the stock decline. As always, the terms and details of these investment instruments should be checked before purchase.”

...Over the past three weeks, however, nobody has really cared about dividends as the S&P 500 (SPX/987.48) has exploded for more than 11%. Somewhat anticipating that explosion, on July 14th we stated that the previous session’s Dow Wow (+185 DJIA) was pretty impressive and perhaps the beginning of “rally redux.” For that reason we recommended buying the indexes. That strategy was driven by what we thought would be better than expected earnings and improving economic fundamentals. Since then, stability has continued in the credit markets, earnings have exceeded expectations, and the economic numbers have surprised on the upside. In fact, the Economic Cycle Research Institute’s Index of Global Industrial Prices has crossed into positive territory for the first time in a year, suggesting the recession is over.

That said, while last Friday’s 2Q09 GDP fell less than anticipated (-1% vs. 1.5%E), the devil was again in the details. Indeed, nominal GDP fell more than expected as the deflator rose by only 0.2% (+1%E). If the deflator would have been in-line real GDP would have declined by 1.8%. Moreover, consumer spending came in at a -1.2% annualized rate despite the government’s 33% (annualized) leap in transfer payments to the household sector. And, maybe that’s why the equity markets were muted last Friday.

Speaking to earnings, according to our friends at the invaluable Bespoke Investment Group, as of Friday 1,220 of the S&P 1500’s companies have reported second quarter earnings. Of those companies 865 have beaten estimates and 106 have been in-line. That leaves the “beat rate” at a surprising 70.9%. Surprising, at least to us, because while we had expected good earnings comparisons in the back half of 2009, when compared to the lousy back half of 2008, we did not expect it for the 2Q09. Still, the S&P 500 pattern from 2003 continues to play in that back then the SPX bottomed in March and rallied into June. From there it flopped / chopped for a while and then broke out above those June 2003 “highs” and tacked on another 15%. Like now, the first leg of that rally was driven by liquidity and the second by improving fundamentals and earnings.

Whatever the reason, the rally has left the NASDAQ Composite (COMP/1978.50) in a “kiss and tell” position, as can be seen in the chart from the must have “minyanville.com” service. This is not an unimportant observation, for the COMP has been the leading index since the March “lows.” Looking at the chart shows that the COMP has rallied back into overhead resistance delineated by the horizontal line. The COMP has also rallied back to a long-standing downtrend line, which should also offer some kind of resistance. Either the COMP stops right here, or it breaks out to the upside and the “melt up” continues.

The call for this week: Well, it’s session 16 in the “buying stampede” (a.k.a. “melt up”) and the typical stampede lasts 17 to 25 sessions, with only one- to three-day pauses / corrections, before they exhaust themselves on the upside. Rather than trying to pick the top, one of the tricks we have learned is to use a short-term moving average, like the 10-day moving average [DMA], and wait for the index to close below it before reducing positions. Currently, the COMP’s 10-DMA is at 1937.42; and we are acting accordingly.

Meanwhile, the interest sensitive D-J Utility Average surrendered 2.48% for the week, the DJ/UBS Commodity Index gained 2.56%, the number of S&P 500 stocks above their 50/200-DMAs is approaching 90% (read: overbought), the Dollar Index tested, and held, its June “lows;” and don’t look now, but Alan Greenspan says the recession may be over, which has the futures sharply higher.