Why I Prefer Dividend-Paying Stocks Like Wells Fargo

| About: Wells Fargo (WFC)


Given the low yield environment, investors are looking for vehicles to generate income in their portfolios.

I prefer dividend-paying stocks to fixed income instruments such as CDs and bonds.

Wells Fargo is a name I like for income portfolios.

We live in a time when CD rates are around 1% on a 1-year basis. A 10-year treasury bond is yielding approximately 2.5%. The problem is that both of these numbers are below the expected inflation rate going forward. So the interest rate you are getting is not keeping up with the inflation rate, and you are actually losing money on a "real return", inflation-adjusted basis.

I much prefer dividend-paying stocks to fixed income instruments such as CDs and bonds. I have a portfolio of 25 dividend-paying stocks designed for income-oriented investors. The yield on that portfolio is around 3.1%, which is higher than the CD rate and the 10-year treasury rate. In addition to the income component of the portfolio, investors also have a chance to participate in capital appreciation.

Now that can go both ways - the portfolio can also go down. But over the next few years, dividend-paying stocks should provide investors with better capital appreciation than fixed income securities. The only way fixed income is going to appreciate considerably is if interest rates go down, and I do not see how rates can go much lower over the next five years. That is why I continue to prefer a portfolio of dividend-paying stocks as a fixed income alternative.

Looking at historical returns, the treasury bond market (NYSEARCA:TLT) has averaged 6.8% over the last 5 years, whereas a portfolio of large cap dividend-paying stocks (NYSEARCA:DLN) has averaged more than 20% over that same time period. And as we look out over the future investment horizon, I think dividend-paying stocks are going to do even better over the next 5 years relative to the bond market than the prior 5 years. Declining interest rates have helped bond market returns over the last few years, but what about the next five years?

Another thing to remember about owning fixed income securities is that you own debt. As an investor, you become a lender, not an owner. You are lending money to an institution, a government, a company, a municipality, or a state. And when you are a lender, you are subject to interest rate and credit risk. While credit quality has improved over the last few years, the 10-year treasury yield has climbed from 1.2% to 2.5%, and that has not been good for debt investors.

Neither bonds nor dividend-paying stocks are riskless investments. Fixed income investments are subject to interest rate and credit risk. Dividend-paying stocks are subject to market risk. That is why I believe in an actively managed portfolio of stocks in order to help manage that risk.

One name in my income portfolio of dividend-paying stocks is Wells Fargo (NYSE:WFC).

Gunderson Capital Best Stocks Now Analysis

(Data from Best Stocks Now app)

Wells Fargo's market capitalization is $273 billion, and it ranks as one of the largest banks in the world. As of March 2014, it operated in 9,000 locations and 12,000 ATMs and offices in 36 countries. The bank was founded in 1852, just after the California Gold Rush, and is headquartered in San Francisco, California.

(Data from Best Stocks Now app)

Not only has Wells Fargo stock beat the 6.8% return of the bond market over the last 5 years, it has also beat the S&P 500 Index, gaining more than 20.1% over that time period. Over the last 3 years, its outperformance has been even better, posting a 3-year average return of 25.6% relative to the S&P 500 Index return of 13.5%. Over the last 12 months, Wells Fargo stock is up 26.6% and its year-to-date return is almost 16%. It has been a top performer in the market.

(Data from Best Stocks Now app)

Despite its strong performance, Wells Fargo is still only trading at 12X forward earnings, at a big discount to the overall market P/E of 17.5. It is true that bank stocks do not trade at the same multiples as a tech stock, but it is still trading at a reasonable multiple. This is especially the case given its expected 5-year growth rate of more than 10% per year. The stock is trading at just a slight premium to its PEG ratio, which is not unusual given its status as a big money center bank. And Wells Fargo pays a dividend of 2.6%, which is more than the 10-year treasury.

Look at the historical chart below. Past performance is not a guarantee of future returns, but which would you rather own: a dividend-paying stock like Wells Fargo or a 10-year treasury bond?

Over the next 3-5 years, what has a better chance of appreciating? Buying a portfolio of 20-25 dividend income names like Wells Fargo is, in my opinion, a better investment than a fixed income portfolio.

Disclosure: The author is long WFC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

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