U.S. Markets closed

Fed Policy Saps 401(k)’s: Why These Stocks Help

Carla Fried

A new study from the non-partisan Employee Benefit Research Institute doesn’t tread in the investing waters, but it nonetheless does a great job explaining why dividend-paying stocks could remain in demand for a very long time.

Jack VanDerhei, EBRI’s research director, has been taking a deep dive into retirement income preparedness (EBRI is one of the most established wonkeries on the topic) in light of especially low interest rates. In his forthcoming research -- given a preview at EBRI’s recent policy forum -- VanDerhei estimates that up to 25% of baby boomers and Gen Xers who would have been just fine in retirement will instead come up short if today’s low rates are permanent.

To be clear, VanDerhei doesn’t expect the Fed’s ZIRP to be permanent, and that 25% figure is predicated on a retiree being fully dependent on retirement income (i.e.-no Social Security safety net.) But that hypothetical data point nonetheless importantly quantifies the angst that pre-retirees are feeling, and reacting to. We’re in year five of low rates, and the Federal Reserve continues to telegraph it expects those rates to stay low through 2015.

That goes a long way to explaining how it is that high-dividend sectors, such as utilities and the consumer defensive sector, continue to post strong performance. Sure, playing defense makes sense in a sketchy slow-growth world here and abroad. But there is also a purely demographic component to the strong showing of defensive stocks. As shown in a chart, stocks with a long history of consistent dividend growth are the answer to a pre-retiree’s prayer for some income in a world where a 5-Year Treasuries yield less than 1% and the highest quality corporate debt pays 2%.

GIS Dividend Yield Chart

Utility stocks offer even better dividend yields -- 4% is the average -- but at a 16.2 forward PE ratio for the S&P 500 utility sector, you’re paying a high price for a notoriously slow growing sector. The consumer defensive sector trades at a higher forward PE of 17.6, but it’s got a whole lot better growth prospects: both in terms of earnings and dividend. That’s not to suggest that some stressed out Boomers aren’t going to keep piling into utilities. But at least with the consumer defensive sector you can hunt for compelling dividend payers that will likely remain popular with the yield seekers, while also delivering some level of fundamental growth and decent valuation.

Using YCharts Stock Screener you can mine for the consumer defensive stocks that not only deliver a solid current yield, but also come through with a decent (if not cheap) valuation, and the ability to keep the dividend growing at an inflation beating pace.

On the left side of the Screener you can drill down to the Consumer Defensive Sector by choosing Sectors under the “Start With” tab and then choosing Consumer Defensive, and “View All.” From there you can start adding filters. This screen demanded a current dividend yield of at least 2.5% from companies with market caps of at least $5 billion. That took the list down to just 20 entries.

To start the winnowing, Forward PE was added as a valuation filter. And to ferret out the financial engineers delivering earnings growth from cost cutting and buybacks from folks producing solid earnings growth via solid revenue growth, the 3-year EBITDA and Earnings Growth were also included. If you’re not applying any socially responsible filters Lorillard (LO) and Phillip Morris (PM) have managed EBITDA and revenue growth of at least 5% over the past three years and sport a below-average PE ratio, a rarity from stocks that yield 5% (Lorillard) and 3.6% (Phillip Morris.) Both companies have also increased their dividend payouts at an annualized rate above 12% for the past three years.

From there though you’re going to have to accept an above-average valuation. Unilever (UL) and its 3.3% yield looks more compelling than Procter & Gamble (PG) which trades at a higher PE ratio and has grown revenue at a slower rate.

Coca-Cola (KO) now sells at a near 20 forward PE. But it was also the only stock on the screen with double-digit earnings and revenue growth over the past three years. The 2.7% dividend yield has come down lately as the price has climbed. But that’s still nearly a full percentage point better than the 10-Year Treasury yield. Add in the value of its long-term buyback plan, and Coca-Cola’s net payout yield (dividends plus repurchases) is an even better 4.3%.

And as this chart shows, despite consistently increasing its dividend payout, Coca-Cola has been spitting out so much free cash flow that its cash dividend payout ratio is now back down to its pre-crisis range.

KO Dividend Chart

Clearly, Coca-Cola will have no problems increasing its income payout to bond battered Baby Boomers.

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 editor@ycharts.com.

More From YCharts