Dividend stocks for solid income while U.S. interest rates remain low

 

Do you think that investing for income is boring?

You’re not alone, and it’s always sexier to tout the next market sector that’s set to soar, or talk about what isn’t working at the moment, namely oil-related stocks.

But many investors rely on income from investments, and with interest rates remaining so low for so long, maintaining and growing this income can be very difficult.

There’s plenty of debate over when the Federal Reserve might begin to raise interest rates. The central bank’s stimulus policy has kept rates low and has encouraged investors who might otherwise have been content with decent bond or CD yields, and who find it difficult to buy preferred stocks (since they get snapped up by institutional investors), to buy common stocks for dividends.

The Fed has kept the short-term federal funds rate locked in a range of zero to 0.25% since late 2008, but that policy is expected to change next year, because the U.S. economy has added more than 200,000 jobs a month for 10 straight months. But when the central bank finally raises the federal funds rate, long-term U.S. rates are likely to stay low.

A major reason for this is that the European Central Bank is considering a huge round of monetary stimulus next year, and China’s central bank has recently cut interest rates. With the U.S. economy growing nicely while other economies are slowing down, and with so much liquidity all over the world, the United States is seen as a safe haven. This has caused the yield on 10-year U.S. Treasury notes to decline by nearly a full percentage point this year.

So it could be a few more years before you have an easy income alternative to stocks.

Volatile Market Swings Represent Return to Reality

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With that in mind, we looked at the highest-yielding components of the S&P 500 Index SPX, +2.40% and found that several of the highest-yielding names are oil drillers that have taken very painful double-digit beatings over the past two months.

Investors are shying away from high-yielding stocks that don’t have clear support for their dividend payouts. So we’re revisiting a strategy outlined in May by Bill McMahon, the chief investment officer of Thomas Partners.

McMahon focuses on identifying companies that not only have attractive dividend yields, but have levels of free cash that could support significantly higher payouts. Free cash flow is a company’s remaining cash flow after capital expenditures.

One approach favored by McMahon is to calculate a company’s cash flow yield, by dividing the free cash flow per share over the past 12 months by the share price. Then a company’s headroom to raise its dividend can be calculated by subtracting its current dividend yield from the cash flow yield.

Here are the 10 S&P 500 stocks with dividend yields of more than 3.5% that have the greatest headroom to raise dividends, based on trailing 12-month free cash flow yields:

Company	Ticker	Industry	Free cash flow yield	Dividend yield	Headroom
LyondellBasell Industries NV	LYB,+4.84%	Specialty Chemicals	11.66%	3.97%	7.70%
Frontier Communications Corp.	FTR,+2.90%	Specialty Telecommunications	11.47%	6.39%	5.08%
Entergy Corp.	ETR,+1.58%	Electric Utilities	8.83%	3.84%	4.99%
CenturyLink Inc.	CTL,+2.04%	Specialty Telecommunications	10.03%	5.75%	4.28%
Coach Inc.	COH,+1.90%	Apparel/ Footwear Retail	7.67%	3.84%	3.83%
Verizon Communications Inc.	VZ,+1.31%	Major Telecommunications	8.53%	4.83%	3.70%
Denbury Resources Inc.	DNR,+2.09%	Oil & Gas Production	7.19%	3.91%	3.29%
Windstream Holdings Inc.	WIN,-1.69%	Specialty Telecommunications	14.68%	11.81%	2.87%
General Electric Co.	GE,+2.91%	Industrial Conglomerates	5.81%	3.70%	2.11%
People’s United Financial Inc.	PBCT,+0.61%	Savings Banks	6.01%	4.53%	1.48%
Source: FactSet

McMahon doesn’t favor using free cash flow yields when looking at financial companies, for which he looks at earnings per share. Using this approach, People’s United Financial Inc.’s  81 cents a share over the past 12 months means an EPS yield of 5.56%, based on Friday’s closing price of $14.57, for headroom of 1.03%.

Here are year-to-date price changes, total returns with dividends reinvested and forward price-to-earnings ratios for the group:

Company	Ticker	Closing price - Dec. 12	Price change - YTD	Total return - YTD	Consensus EPS estimate - 2016	Forward P/E
LyondellBasell Industries NV	LYB	$70.61	-12%	-10%	$8.78	8.0
Frontier Communications Corp.	FTR	$6.26	35%	44%	$0.23	26.9
Entergy Corp.	ETR	$86.41	37%	43%	$5.41	16.0
CenturyLink Inc.	CTL	$37.58	18%	25%	$2.52	14.9
Coach Inc.	COH	$35.20	-37%	-35%	$2.04	17.3
Verizon Communications Inc.	VZ	$45.58	-7%	-3%	$3.75	12.1
Denbury Resources Inc.	DNR	$6.40	-61%	-60%	$0.71	9.0
Windstream Holdings Inc.	WIN	$8.47	6%	15%	$0.15	56.0
General Electric Co.	GE	$24.89	-11%	-9%	$1.79	13.9
People’s United Financial Inc.	PBCT	$14.57	-4%	1%	$0.89	16.4
Source: FactSet

In comparison, the S&P 500 is up 8% this year and has returned 10.5% with dividends reinvested. The index trades for 14.0 times the aggregate of consensus 2016 earnings estimates.

This list is meant to be a starting point for your own research. It’s very important to dig deeply when considering an investment, in order to understand a company’s strategy and threats to the strategy and to the dividend. For example, shares of Coach Inc. are down 37% this year, and the company reported a 24% decline in fiscal first-quarter comparable sales

Denbury Resources Inc. is down 61% this year, as the drop in oil prices has taken its toll.

The bottom line is that there are plenty of good dividend stocks to be had while interest rates remain at historically low levels. A long-term commitment backed up by your own research can help ensure that the income keeps flowing.

Source url:http://www.marketwatch.com/story/dividend-stocks-for-solid-income-while-interest-rates-remain-low-2014-12-16