High-Quality Income Plays Yielding At Least 3%

by: Pragmatic Bear

Today I would like to look at some of my favorite stocks yielding over 3%. A few key factors I'm looking for are a low dividend payout ratio and solid history of paying and increasing dividends. I want to also keep this basket of stocks as diversified as possible. With the ten-year Treasury yielding below 2%, a need has arisen to look for better-paying investments. I want to make it clear that this is not a recommendation to buy these stocks at their current prices. As I have mentioned in previous articles, I am of the opinion that there is between a 20-40% chance of a slide back into recession. The prudent move may be to wait until the slide starts or the sky clears before you start adding positions. However, I believe that these stocks will be beneficial to your portfolio in a recession or a low-growth environment.

Dividend Yield
Payout Ratio
Sector Industry
Cononco Phillips (NYSE:COP) 4.00% 30% Energy Major Integrated Oil & Gas


6.10% 50% Technology Telecom - Services
Johnson & Johnson (NYSE:JNJ) 3.60% 52% Healthcare Drug Manufacturer
Novartis (NYSE:NVS) 3.50% 47% Healthcare

Drug Manufacturer

Philip Morris (NYSE:PM) 3.80% 59% Consumer Goods Cigarettes
Kraft Foods (KFT) 3.40% 67% Consumer Goods Food - Diversified
Paychex (NASDAQ:PAYX) 4.80% 87% Services Staffing & Outsourcing
PepsiCo (NYSE:PEP) 3.30% 50% Consumer Goods Beverages
Intel (NASDAQ:INTC) 4.30% 31% Technology Semiconductors
Illinois Tool Works (NYSE:ITW) 3.30% 35% Industrial Goods Diversified Machinery
Home Depot (NYSE:HD) 3.10% 44% Services Home Improvement Stores
Chevron (NYSE:CVX) 3.20% 26% Energy Major Integrated Oil & Gas
Canadian Imperial Bank of Commerce (NYSE:CM) 4.80% 51% Financial Money Center Banks
Raytheon (NYSE:RTN) 4.20% 28% Defense Aerospace - Diversified
Kellogg Company (NYSE:K) 3.20% 48% Consumer Goods Processed and Package Goods
Avon Product (NYSE:AVP) 4.30% 53% Consumer Goods Personal Products
Kimberly Clark (NYSE:KMB) 4.10% 64% Consumer Goods Personal Products
General Mills (NYSE:GIS) 3.30% 41% Consumer Goods Processed and Packaged Goods
Microchip Technology (NASDAQ:MCHP) 4.40% 64% Technology Semiconductors
Toronto Dominion (NYSE:TD) 3.50% 43% Financial Money Center Banks
Reynolds American Inc. (NYSE:RAI) 5.70% 87% Consumer Goods Cigarettes
Verizon (NYSE:VZ) 5.50% 102% Technology Teecom-Services

Some others that I would be very interested in, if their yields could get up to 3%:

McDonalds (NYSE:MCD) 2.70% 48% Services Resturants
Coca-Cola (NYSE:KO) 2.70% 34% Consumer Goods Beverages

Now I would like to take a look at some of these companies in greater depth.

Novartis and Johnson & Johnson: Let me preface these stocks by stating my overall bullish attitude towards the healthcare sector. Healthcare has been shown to be one of the few sectors resistant to recessions. In fact, in the latest disappointing job report the healthcare sector actually added positions. Novartis engages in the research, development, manufacture, and marketing of healthcare products worldwide. They are based out of Switzerland. Currently they are trading at 13.20(ttm) x past earnings and 9.66 x future earnings. This means that it is trading at a discount to another favorite of mine, Johnson and Johnson (JNJ). NVS and JNJ yields are separated by only 10 bps at this time. They also have very similar dividend payout ratios hovering around 50%. Both have solid histories of paying and increasing their dividends. Johnson & Johnson has been paying dividends since 1944 and increasing the payments for 47 straight years. Since the merger that created the company in 1996, NVS has issued and increased its dividend every year. In my opinion JNJ has the stronger balance sheet, with almost 30 billion in cash compared to NVS’s 6 billion. Either of these Healthcare stocks will perform well in an uncertain economic environment.

Canadian Imperial Bank of Commerce and Toronto Dominion: I have been interested in for some time in taking a look at the financial institutions of Canada. For several months now, while the United States and Europe’s banks have been getting absolutely hammered by the market, the banks in Canada have performed admirably. In fact, year to date, TD is up 4% and CM is only down by 2.87%. This looks fantastic compared to the negative returns of Citigroup (NYSE:C), Bank of America (NYSE:BAC), and Goldman Sachs (NYSE:GS), down 41.43%, 47.60%, and 37.82% respectively. Both of these Canadian banks provide solid yields (CM at 4.80% and TD at 3.50%) and low payout ratios (CM at 51% and TD at 43%). Both have issued dividends since at least 1997. Their dividends did stagnate in the past few years due to the financial crisis, but they appear to be on the rise again. If you are looking to get some exposure to financials, I think our neighbor to the north has some of the safest ones on the planet.

AT&T and Verizon: I know I write about AT&T all the time, but it is without a doubt one of my favorite dividend stocks out there. It currently has a market cap of $165 billion, which makes it one of the largest companies on this list. There are 3 major factors that push me to favor AT&T over their closest competitor in the telecommunications market, Verizon (VZ). First, T is trading at a much lower multiple of 8.11 compared to their major competitor Verizon at 15.80. In terms of their dividend, T also has the edge. AT&T is currently yielding 6.10% with a 50% payout ratio, compared to VZ, which has a 5.50% yield with a 102% payout ratio. This says to me that T’s dividend is the safer play. Lastly, AT&T is not encumbered by the long-term debt issues that Verizon has. If you are looking for consistency, look no further. AT&T has issued and increased its dividend for the past 28 years. The company has been in the news as of late as the department of justice moved to block its potential merger with T-Mobile. I would look for any retraction of the stock price as a buying opportunity, especially under the $28 mark. These are the major reasons that lead me to the opinion that AT&T is the best in show.

Paychex is a payroll and human resource service company which serves approximately 572,000 businesses in the US. Paychex provides payroll, human resource, and benefits outsourcing solutions for small-to medium-sized businesses in the United States and Germany. Currently it is trading at a trailing multiple of 18.15 and a forward multiple of 15.71. At present it has a dividend yield of 4.70% with a payout ratio of 87%. The reason I included this company with a ratio this high is due to the fact that the company has no outstanding debt. By taking a look at their dividend history you would notice they have been issuing since 1988. Although they haven’t raised their dividend since 2009, for the previous 17 years it had grown substantially.

Intel and Microchip Technology: These companies are two of the largest producers of semiconductors in world. At their current valuations Intel is priced at a discount to Microchip Technologies. INTC’s trailing P/E ratio is 8.97 and their forward P/E is 7.91. MCHP is more expensive at 14.54 x past earnings and 13.99 x future earnings. They both have similar dividend yields at 4.30% and 4.40%, respectively. Intel’s payout ratio is about half of MCHP at 31% to 64%. This leads me to the assumption that Intel’s dividend is somewhat safer and has more potential for growth. Intel also has the stronger dividend history, as they have been making payouts since 1992. Intel's dividend has steadily increased at a 33 percent compound annual growth rate since 2003. MCHP started their dividend payments in 2003. Since 2007 the growth rate of their dividend has slowed dramatically from the years before.

Over the past few months the technology sector has really taken a beating, and these two companies are no exception. Intel and Micro are down 10.5% and 16% respectively in the last 3 months. Some of this downward movement is due to the fears that future PC sales will be hampered by the tablet revolution. I think this is somewhat short-sighted. While tablets have proven to be an outstanding new device, I highly doubt that they are the long-term replacement for your everyday personal computer. Also, Intel is trying to break into this market. Selling at a cheaper multiple and providing a more solid, faster-growing dividend gives Intel the edge in this match-up.

Home Depot Is the largest hardware chain in the United States and Europe. It operates 2,248 stores locations in the United States, Canada, Mexico, and China. Home Depot has a market cap of 50 billion and is currently trading at multiples of 14.33 x past earnings and 11.91 x future earnings. HD has a quarterly dividend of $0.25, giving it a yield of 3.10%. They have consistently paid a dividend for the past 24 years. One negative aspect of Home Depot’s dividend is that 2011 will mark only the second year of consecutive increases. However, CEO Frank Blake was quoted as saying “It is our intent to increase our dividend every year. Our longer-term targeted dividend payout ratio is 40 percent.” With 2011 shaping up to be another good year for HD, it is very likely that it will increase for a third year.

PepsiCo and Coca-Cola: PepsiCo engages in the manufacture, marketing, and sale of foods, snacks, and carbonated and non-carbonated beverages worldwide. At present it has a trailing P/E ratio of 15.89 and a forward multiple of 12.85. Also it provides the investor with a solid 3.30% yield and a low payout ratio of 50%. There is still a ton of growth potential for this dividend. PepsiCo recently renewed their deal with the National Football League. This lucrative 10-year, $2.3 billion extension keeps Pepsi as the exclusive beverage company of the league. PEP actually has a higher dividend yield and a lower multiple than their major competitor, Coca-Cola (KO). Both of these have exceptional dividend histories. KO has been raising its payout for 48 consecutive years, while Pepsi has been good for an increase for 39 years. However, in my opinion Coke has the stronger balance sheet and greater international exposure. Also I am quite partial to stocks that Warren Buffet has his money in, and he is a big proponent of Coke. If there was a considerable retraction, I would take a look at PEP. However, what I really want is for KO to fall to the more attractive yield level of 3%.

Conoco Phillips and Chevron: These are two of the largest oil and gas producers in the world with market caps of 90 billion and 191 billion. I wanted to include some energy stocks in this basket. Year to date CVX is up about 4% and COP is down by about 3%. However, on the 5-year scale CVX is 47.47% while COP is only up 2.27%. They are trading at very similar multiple levels (8 trailing and 7 forward). Conoco is yielding 4.00% which is about 80 bps better than Chevron. Also they both have extremely low payout ratios of right around 30%. Integrated oil seems to move in lock step with each other. Personally, I like CVX a little bit more than COP. The major reason comes from their stronger balance sheet that has more cash and less debt. I just think Chevron looks like a slightly more solid company.

Kellogg and General Mills: Both are American companies that manufacture and sell branded food products worldwide. K has a 3.20% dividend yield while GIS is at 3.30%. Both have low payout ratios at 48% and 41% respectively. GIS has a market cap of $24.19B and P/E ratio 13.66. K is trading at a slight premium to GIS with a multiple around 16. The performance of these two companies' share prices over the past 5 years has been mixed. GIS is up 35.71% during this period while K is only up 5%. They both have solid dividend histories of paying and issuing dividends for over 20 years. I like both of these companies, but if push comes to shove I would be more interested in GIS, with its higher yield, lower multiple, and better overall performance during the last 5 years. Even as the economy shows signs of weakness, people will still reach for their favorite cereals at the grocery store.

Philip Morris and Reynolds American: Last but not least, I would like to take a look at two of the largest players in the cigarette and tobacco products markets. This is also an industry that has proven to be quite recession-resistant in the past. For this comparison I chose two companies on different sides of the same market. PM is the much larger company with a market cap of $119 billion and a forward P/E ratio of 12.97. It has a very stable yield of 3.80% and a payout ratio of 59%, which is well below industry average. It has been paying dividends since it was spun off of its parent company Altria in 2008. RAI, on the other hand, has a smaller market cap of about $21 billion and a much higher yield of 5.70%. It also has a much higher payout ratio of 87%. This worries me a bit, as this could signal a lack of room for significant dividend growth in the future. However, since 2000 they have increased their dividend every year, with the exception of 2004. So far in 2011 RAI has raised its dividend 15.2%. If you don’t have a moral aversion to owning stock in a company that kills people, big tobacco might be the place for you.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.