Ten-year Treasuries are still yielding less than 3%, despite a recent rebound in yields. Since that's not very much, I looked to see how easy it would be to create a diversified portfolio with higher yielding stocks.
There were three primary characteristics I sought out in potential candidates. The first was a history of dividends, so I required five consecutive years of dividend payments. Second, I wanted companies that generated cash from their business operations. Therefore, I looked for companies that have reported five consecutive years of positive cash flow from operations. (Located on the cash flow statement, this number shows whether a company's business operations is producing or using up cash.) Finally, being a value guy, I did not want to overpay, so I required a price-earnings ratio below 20.
This basic, but restrictive, screen found 149 companies. More importantly, the range of industries represented was broad enough to create a diversified portfolio. For example, an investor could combine Pfizer (NYSE:PFE), Verizon (NYSE:VZ), Southern Copper (NYSE:SCCO), Simon Property Group (NYSE:SPG), Paychex (NASDAQ:PAYX), Maxim Integrated Products (NASDAQ:MXIM) and R.R. Donnelley & Sons (NASDAQ:RRD) into a portfolio with a higher overall yield than 10-year Treasuries. Industries represented in this portfolio include pharmaceuticals, telecom services, mining, real estate, business services, semiconductors and printing. You could also easily diversify across market capitalizations, with several small-cap stocks making the screen's cut.
The screen shows that it's fairly easy to create a diversified portfolio with a higher current yield than 10-year Treasuries. The bigger question, however, is whether you should. The answer depends on what your reasons are.
If it is to replace bonds, consider that when held to maturity, bonds provide a fixed return of capital; stocks provide an uncertain return. If, instead, you are looking to supplement the income produced by your bond holdings, then yes, a diversified portfolio of dividend-paying stocks makes sense. (Just keep in mind that the ones I just mentioned were selected purely for the purpose of a providing an example of what is possible.)
But what if you're looking at higher yielding stocks purely from the standpoint of maximizing returns? In such instances, an argument can be made that you should be agnostic about dividends. What matters is not whether or not the company is paying dividends, but rather how well the company is being run, what the valuation looks like and what future prospects look like. Your goal should be to find the stock that offers the best potential to build wealth, regardless of whether the return is comes from price appreciation or dividend payments.
(For full disclosure, I personally prefer companies that pay dividends, simply because I think the requirement for regular cash outflows holds management more fiscally accountable. Though I'm not agnostic about dividends, I will buy a non-dividend-yielding stock that is otherwise highly attractive because I do realize my end goal for investing is to build wealth.)
Charles Rotblut, CFA is a Vice President with AAII and editor of the AAII Journal.