Breakout

Yield of dreams: Investors have "a once in a lifetime opportunity" in blue chips

Jeff Macke
Breakout

Yield of dreams: Investors have "a once in a lifetime opportunity" in blue chips

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Yield of dreams: Investors have "a once in a lifetime opportunity" in blue chips

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Over the last two years shares of McDonald’s (MCD) couldn’t have been colder or more inert if you hung them in a meat locker. In that time, shares of the deposed burger leader have fallen more than 5% while the S&P 500 (^GSPC) has gone up 30%.

Hank Smith of Haverford claims there’s more to the story with high-yielding blue chips. “You can buy high quality companies whose dividend yields exceed that of fixed income bonds,” Smith says in the attached video. That’s unusual. In fact, according to Smith investors would have to go all the way back to the mid-1950's to find the last time it was this easy to find so many companies where the dividend yield exceeded that of their bonds.

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(A brief Investing 101 aside: Companies can raise money by issuing stock or debt - bonds. If the company goes out of business debt holders are paid first and equity holders get anything left after that. In order to compensate for that additional risk stocks offer greater upside potential than bonds. In addition, where bonds have to pay interest until expiration, stock can be held indefinitely. Companies with strong cash flow are able to issue debt for only slightly more than the “risk free” government rate. With rates pegged at zero by the Fed and economy stable, if not strong, corporate bond yields are unusually low. Back to Smith.)

The downside risk for investors is the increased volatility of equity. McDonald's is no where near going out of business, but it's also operationally stagnant. The company is a great bet to pay back its debt, but achieving growth is a different matter. The old saw about high-yield stocks “paying you to wait” assumes the share price will eventually move higher. If MCD shares drop to $50 and the dividend stays unchanged, shareholders would be getting a 6.5% yield but their shares would need to nearly double before they got back to even.

“That is the cost of being a dividend investor,” says Smith “You have to accept volatility, but if you have an intermediate to long-term perspective you’re buying McDonald’s stock today with a 3.5% dividend and you’re almost assured to get a dividend increase each year. If you buy the McDonald’s eight year bond you’re getting about a 2.8% yield and I guarantee you that yield is not going to change over the next eight years.”

It’s not just McDonald’s. Smith points out that every sector of the S&P 500 has high quality companies with stocks yielding more than their 10-year bond. They may not be glamorous, but over the long haul these companies may be a good way to get equity exposure with less equity risk than momentum plays.

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