It came a week late, but Congress gave Federal Reserve chairman Ben Bernanke and risk-averse income investors a belated Christmas present. As part of the fiscal cliff deal, the 15% tax rate on qualified dividends is not budging one iota for about 99% of investors.
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Only individuals with income above $400,000 and married couples brining in more than $450,000 will pay a higher rate in 2013 and beyond. But even that is a gift as well, rising to just 20%. That’s about half of where it could have been if President Obama’s plan to tax dividends at ordinary income tax rates for high earners had been enacted.
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The dividend piece of the fiscal cliff deal qualifies as borderline fiscal stimulus from this Congress. Granted it’s not the scale of what Bernanke keeps pushing for, but giving dividend paying stocks tax-favored status over bonds (taxed as ordinary income) should continue to pressure more income investors to seek out dividend stocks over “safe” bonds. You know the routine by now: The 10 year Treasury yields less than 2% and high quality corporate bonds are stuck below 3%. Meanwhile, plenty of dividend-paying stocks have current yields north of 3%.
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A quick YChart Stock Screener turned up more than 100 stocks with market caps of at least $10 billion that have dividend yields between 3% and 5%. Why stop at 5%? It’s admittedly a totally arbitrary cutoff, but at more than double the yield on the S&P 500 it seems plenty generous without sending us into the land of basket cases or higher risk turnaround/deep value plays. Sticking to stocks with 3%-5% dividend yields is a reasonable sweet spot for investors looking for solid bond alternatives.
A decent current dividend yield is just a start point. The next step is to look for companies with the good habit of consistent dividend increases that are above the rate of inflation. Historically stocks with rising dividends have outperformed non-dividend payers, and companies that pay a dividend but don’t consistently raise the payout. The inflation hurdle -- just 3% or so these days -- offers the prospect of a rising income stream that can preserve purchasing power; that’s something high quality bonds with sub 3% yields fail to do today.
Screening out stocks with super-high payout ratios boosts the odds that dividend hikes can continue without stressing out a company’s balance sheets.
To keep the shopping list to decent values, only stocks with PE multiples below 120% of the S&P 500's 14 trailing PE were considered.
Diversified energy firms Chevron (CVX) and Conoco Phillips (COP) sport the lowest PE ratios on our YCharts screen. Chevron’s current dividend yield is 3.3%, Conoco-Phillips pays a steeper 4.6%. Earnings -- and stock performance -- has languished along with the decline in oil prices. Their sub 10 PEs price in the cyclicality; those bond-beating dividend yields are decent recompense for waiting for the next up cycle in energy demand.
The most speculative stock oh the list is aerospace manufacturer Lockheed-Martin (LMT), which pays a fat current yield of 5%. The problem of course is the prospect of steep cuts in U.S. defense spending as part of ongoing Congressional fiscal wrangling. The Defense Department accounts for about 60% of Lockheed-Martin’s revenue, and government spending in total comprises 80% of the firm’s revenue.
Perhaps the least speculative stock on the list is General Mills (GIS), which has been paying out a dividend for more than 100 years and relies on basic consumer demand for food, not government contracts. General Mills has a current dividend yield of 3.3% and dividend boosts over the past decade have dwarfed inflation.
General Mills’ profit growth has impressively lapped competitors, Kellogg (NYSE:K) and Campbell Soup (CPB).
Genuine Parts (GPC), a recent addition to the Berkshire Hathaway (BRK-B) portfolio barely made it onto the list with a 3.1% yield. The automotive and industrial replacement parts distributor has a 50-year plus track record of raising its dividend. While earnings have rebounded strongly from the recession, the stock’s valuation hasn’t budged much.
A solid current yield, a commitment to dividend growth selling at a compelling valuation is just the sort of stock that can warm a frustrated bond investor’s heart and portfolio.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at email@example.com.