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Are you surprised U.S. Treasury bonds have outperformed stocks this year?
The Bloomberg U.S. Treasury Bond Index returned 3.2% through the end of last week, beating the S&P 500 Index's (.SPX) 2% gain as investors have lost their nerves with equities pushing up against record highs.
It's been a topsy-turvy market, for sure. The yield on 10-year U.S. Treasury bonds rose to about 3% at the end of 2013 from 1.78% a year earlier, with selling pressure increasing as investors anticipated the Federal Reserve's decision in December to begin reducing its purchases of bonds. But investors have poured money into Treasurys this year, sending the yield on the 10-year bond down to 2.52% on Friday. And companies around the world have raised a record $368 billion this year from bonds maturing in 10 years or more, Bloomberg News reports.
The Fed's bond buying and its policy of keeping the federal funds rate close to zero since late 2008 has boosted the money supply at a rate far exceeding that of gross domestic product growth. According to the central bank's figures, M2 — the sum of money held by the public in transaction accounts, money market accounts and retail money market funds, as well as time deposits with balances of less than $100,000 — increased 2% in the first four months of this year.
During 2013, M2 swelled 5.4%, while the estimated GDP growth rate was 1.9%. In 2012, it was 8.3% and 2.8% — this pattern has gone on for years. The bottom line is that the money has to go somewhere, which helps explain the stock market's explosion over the past two years, and Treasurys' rebound this year.
The Federal Reserve expects to wind down its bond purchases this year, and could decide in 2015 to begin raising the federal funds rate.
At some point soon, at least, the money spigot will be turned off. That will mean downward pressure on bond prices and possibly some pain for stock investors as well. This prediction has been made for the past several years, and this year's action has shown just how premature many investors were last year in expecting a radically changed interest-rate environment.
Investors seeking current income may well be better off building positions in quality companies paying high dividends on common shares.
Warren Buffett has recently done just that. His Berkshire Hathaway Inc. (BRK/B) in a 13F filing disclosed that during the first quarter it built up a new position in Verizon Communications Inc. (VZ) shares. Berkshire held 11,022,743 Verizon shares worth $524 million. Verizon pays out 53 cents per share each quarter, for a yield of 4.42%, based on Thursday's closing price of $47.96. So Berkshire's annual dividend on its Verizon stake comes to a tidy sum of $23.4 million.
To develop a list of buoyant dividend stocks that might be better choices for income and safety over the next few years, we pared the S&P 500 to the five stocks with the highest dividend yields that also meet two other quality standards. All have shown growth in annual sales per share over the past two years and produced sufficient free cash flow during 2013 to more than cover dividends, according to data provided by FactSet.
|Company||Ticker||Annual dividend||Yield||Forward P/E|
|Peoples United Financial||PBCT||$0.66||4.65%||15.1|
Please see accompanying article for stock selection criteria
Total returns assume dividends are reinvested
Source: FactSet, based on closing prices on May 15, 2014
Interestingly, three telecommunications firms made the list, as well as the leading U.S. cigarette manufacturer and a regional bank. Here's more information on all five:
CenturyLink Inc. (CTL) is a telecom-services provider headquartered in Monroe, La., that operates land lines in 37 states. CenturyLink also offers broadband Internet services, runs 55 data centers in North America, Europe and Asia, and also provides various data, cloud and hosting services to corporate clients.
CenturyLink's stock closed at $37.82 Thursday, returning 21% this year, following a 13% decline during 2013. Those figures compare with 2% and 33%, respectively, for the S&P 500. CenturyLink pays a quarterly dividend of 54 cents, for a yield of 5.71%, the highest on the list. The company's free cash flow last year totaled $4.18 a share, showing it covered the dividend comfortably.
For the first quarter, CenturyLink reported net income of $203 million, or 35 cents a share, down from $298 million, or 48 cents, a year earlier. Adjusted core revenue was "nearly flat" at $4.11, which was an improvement from a 2% decline a year earlier. The company also reported solid growth of 66,000 high-speed Internet customers and 24,000 customers for its Prism TV service. That helped mitigate the continued decline in revenue from legacy (land line and long distance) services, which was down 6% to $1.83 billion.
Meanwhile, the company reported a 5.4% increase in adjusted strategic segment revenue (which includes broadband service) to $2.16 billion, and a 24% rise in data integration revenue to $174 million.
Investors' enthusiasm this year reflects confidence in the company's ability to continue throwing off sufficient cash to support the dividend, while navigating the continued transition from land-line services.
CenturyLink provided second-quarter guidance, including core revenue ranging from $4.07 billion to $4.12 billion and adjusted diluting EPS ranging from 62 cents to 67 cents.
AT&T Inc. (T) is next, with a dividend yield of 5.04%, based on a quarterly payout of 46 cents and Thursday's closing price of $36.52. The stock has returned 7% this year, following a 10% gain in 2013. The shares trade for 12.9 times the consensus 2015 earnings estimate of $2.84 among analysts polled by FactSet. That's the second-lowest forward price-to-earnings ratio among the five dividend stocks listed here.
AT&T agreed over the weekend to acquire DirecTV (DTV) for $95 a share, which is a 10% premium to DirecTV's closing price of $86.18 on Friday. Then again, DirecTV's shares had already risen 11% since the end of April.
"Given the structure of this transaction, which includes AT&T stock consideration as part of the deal and the monetization of none-core assets, AT&T expects to continue to maintain the strongest balance sheet in the industry following the transaction close," the companies said in a joint press release.
AT&T will pay about $48.5 billion for DirecTV, and the purchase will be made with roughly 30% cash and 70% stock. Factoring in DirecTV's debt, the total value of the deal is $67.1 billion. The issuance of new shares means a significantly higher dividend payout for AT&T, but the combination will also increase free cash flow per share by 7% to 10%, and lower the company's ratio of dividends paid to earnings per share to about 79% from a range of 84% to 88%, according to an estimate by Jefferies analyst Mike McCormack.
But in a note to clients Monday, McCormack questioned the "strategic value given long-term challenges of satellite video amid evolving consumer viewing habits."
Still, he rates AT&T "buy," with a $40 price target.
Altria Group Inc. (MO) is the former Philip Morris, which was split into two companies in 2008, with Altria taking the U.S. tobacco business and the rest being spun off to the new Philip Morris International Inc. (PM).
Altria's stock closed at $40.05 Thursday, returning 6% this year, after advancing 29% in 2013. The company pays a quarterly dividend of 48 cents, for a yield of 4.79%. (Philip Morris International also has an attractive dividend yield of 4.41%, based on a quarterly payout of 94 cents and Thursday's closing price of $85.33.)
Getting back to Altria, an investor's first thought about a company deriving most of its revenue from smokable tobacco products in the United States might be to run because of the decline in smoking. The huge excise taxes charged in some states, which can double the cost of cigarettes, the unwillingness of some retailers, including CVS Caremark Corp.'s (CVS) CVS Pharmacy, and, of course, the known effects of smoking on health, are all strikes against the company. But a closer look at Alria's financial statements shows strong results that may surprise you.
The company has managed to grow its revenue per share for the past five years, in part, because of stock buybacks. But as tobacco sales of its main subsidiary, Philip Morris USA, drop, the company has also been diversifying with smokeless tobacco products and St. Michelle Wine Estates, which it acquired in 2009.
During 2013, net revenue from smokeable products declined by 2% to $21.87 billion, but a decline in excise taxes led to an adjusted 2% rise in operating companies income (OCI) for the unit to $$6.42 billion. Altria defines OCI as "operating income before corporate expenses and amortization of intangibles."
Meanwhile, net revenue for smokeless tobacco products, including "moist smokeless" products and electronic cigarettes, rose 4% to $1.65 billion. The unit's adjusted OCI for 2013 increased 7% to $1.03 billion. Altria entered the "e-vapor category" last year, through the limited rollout of MarkTen electronic cigarettes, which is expanding this year. The company also purchased e-cigarette manufacturer Green Smoke in April for $110 million in cash and "up to $20 million in incentive payments."
Altria's wine revenue grew 9% to $587 million during 2013, while the unit's OCI was up 13.5% to $118 million.
So 2013 was a good operating year, with total OCI increasing 2% to $1.86 billion. A loss of $1.08 billion on the early extinguishment of debt caused a decline in net earnings to $488 million, or 24 cents a share, from $1.1 billion, or 55 cents, a year earlier.
For the first quarter, Altria reported higher OCI in all segments, with lower excise taxes helping the smokeable tobacco segment. But the company's cost for states' legal tobacco settlements increased by 73% to $1.08 billion. So first-quarter net earnings declined to $1.18 billion, or 59 cents a share, from $1.39 billion, or 69 cents. But excluding special items, earnings rose to $1.44 billion, or 57 cents, from $1.09 billion, or 54 cents.
Altria in April raised its 2014 guidance slightly, to a range of $2.53 a share to $2.60, and said it expected to maintain "a dividend payout ratio target of approximately 80% of its adjusted diluted EPS," which is well above the current payout.
Altria is very much a cash flow play, and its relatively rich valuation at 14.5 times the consensus 2015 EPS estimate of $2.76 shows investors are confident in management's ability to continue growing revenue per share. This company is a good example of how deeply you should dig into a company's financials and how important it is to understand its business strategy before jumping in.
People's United Financial Inc. (PBCT) is a regional bank headquartered in Bridgeport, Conn., with $33 billion in total assets and 410 branches in New England and southeastern New York. The stock closed at $14.20 Thursday, down 4% this year, following a 31% return during 2013.
Based on a quarterly dividend of 16.5 cents, the stock has a dividend yield of 4.65%.
People's United reported first-quarter earnings of $53.1 million, or 18 cents a share, increasing from $52.5 million, or 16 cents, a year earlier. Net interest income rose to $227.1 million from $219.3 million, despite a narrowing of the net interest margin to 3.17% from 3.38%. The higher net interest income reflected loan growth that could only be described as outstanding for a regional bank in this environment.
The bank's average total loans during the first quarter grew by an impressive 12% to $24.2 billion from a year earlier. All major loan types saw growth, and commercial real estate lending was strongest, with average loans up 20% to $8.9 billion.
People's United's stock trades for 15.1 times the consensus 2015 EPS estimate of 94 cents. That's a pretty high valuation for a large regional bank, but the dividend is attractive so investors are paid nicely to wait until the eventual sustained rise in long-term interest rates widens the net interest margin and significantly boosts earnings.
Verizon (VZ) is the last company on our list of the five S&P 500 stocks with the highest dividend yields that have also grown sales per share for the past five years and showed 2013 free cash flow that was higher than dividends.
Warren Buffett's recent decision for Berkshire Hathaway to buy a large block of Verizon shares speaks volumes.
The company's first-quarter operating revenue was up 5% from a year earlier to $30.82 billion, while its operating income rose 15% to $7.16 billion. Net income was up 23% to $5.99 billion, while EPS rose to $1.15 from 68 cents. The results reflected less than a full quarter of full ownership of Verizon Wireless, since the company completed its $120 billion purchase of the 45% stake held by Vodafone Group PLC (VOD) on Feb. 21.
Verizon's operating cash flow declined to $7.1 billion from $7.5 billion a year earlier. "Cash flow included an incremental $1.3 billion in interest payments and $200 million in pension funding that the company did not have in first-quarter 2013," the company said, referring mainly to the $49 billion bond offering the company completed last September, as part of the cash and stock deal with Vodafone.
Free cash flow declined to $3 billion from $3.9 billion, but the company also said: "On a comparable basis, free cash flow available to Verizon Communications was approximately $1.4 billion higher in first-quarter 2014 than in first-quarter 2013, assuming all free cash flow at Verizon Wireless had been distributed to the partners."
Verizon's guidance calls for 4% revenue growth this year. The stock trades for 12.4 times the consensus 2015 EPS estimate of $3.85. That's the lowest forward P/E among the five dividend stocks listed here. The consensus 2014 EPS estimate is $3.54.