The sharp drop in bond yields has heightened the appeal of stocks with high dividends, and the recent selloff in the stock market has created plenty of them.
There were 55 stocks in the S&P 500 index (.SPX) with dividend yields of 5% or higher at the close of trading on Thursday. More joined the club after the market drop on Friday.
A nearby table lists a dozen of them, including well-known companies like Altria Group (MO), Chevron (CVX) Exxon Mobil (XOM), AT&T (T), AbbVie (ABBV), Prudential Financial (PRU), Dow (DOW), and Wells Fargo (WFC). With the 10-year Treasury note hitting a record low yield of 0.7% on Friday and with 10-year, top-grade municipal bonds below 1%, these dividend yields look attractive in comparison.
Risk does come with high dividend yields, however. Many investors view high-yielding stocks as value traps rather as opportunities.
Cornerstone Macro strategist Michael Kantrowitz wrote recently that high-dividend stocks haven’t derived much benefit from declining interest rates over the past 15 years and have seen their weighting in the S&P 500 steadily decline. “Stocks with high dividends sometimes have far worse fundamentals than peers,” he wrote.
Yes, investors need to be careful, but the dividends on these dozen companies look secure based on payout ratios using projected 2020 earnings, the strength of their balance sheets, and the durability of the businesses.
An indicator of dividend strength is a company’s bond yield. One encouraging sign for the dozen is that dividend yields comfortably exceed the yields on each company’s debt. This wide gap in favor of dividends indicates that equity investors may be overly concerned about dividend safety.
“One area that is vastly oversold is energy,” says Charles Lieberman, the chief investment officer at Advisors Capital Management in Ridgewood, N.J. “Investors have been burned, and retail investors are fleeing.”
Energy stocks took another beating on Friday as West Texas Intermediate crude fell $4.38, to $41.53 a barrel. The Energy Select Sector SPDR exchange-traded fund (XLE), which is dominated by Exxon and Chevron, was down 5.6%, to $42.50, after falling to its lowest level since the financial crisis.
Lieberman is partial to a group of energy pipeline companies including Kinder Morgan (KMI), an industry leader whose shares trade around $20 and yield 5%. Pipeline operators carry less risk from lower energy prices than do producers because of their contracts to carry oil products and natural gas.
“Kinder Morgan is more of a tolling company,” says Michael Jamison, a manager director at Griffin Asset Management in New York. “The economics of the contracts don’t change when energy prices change.”
Kinder Morgan’s payout ratio, based on reported earnings, is above 100% but is about 50% based on its discretionary cash flow. Kinder Morgan is projecting a 25% increase in its dividend in 2020 to $1.25 a share.
Exxon hit a 15-year low of $48 on Friday and now yields over 7%, its highest yield in more than 30 years. Exxon’s payout ratio is above 100%—a warning sign—after it took on about $9 billion in debt during 2019 to help pay its dividend.
With a triple-A bond rating from Moody’s and still modest debt relative to cash flow and rock-bottom borrowing costs, Exxon can borrow for a while to fund its dividend if energy prices stay low. The company not only backed the dividend at its investor day this past week, but stated that it remained “committed to a reliable and growing dividend.” Exxon has a record of 37 consecutive years of dividend increases. Another could come in April, when it typically lifts its dividend.
The oil giant, however, is more stretched than any of its major peers, given its high capital spending as part of a program to increase energy production by about 25% by 2025.
Investors are uncomfortable with that. The historically defensive stock is now the worst performer in the Dow Jones Industrial Average (.DJI) this year, with a 32% decline.
Exxon’s dividend break-even—the Brent crude price at which it covers its dividend from free cash flow—is above $80 a barrel, against under $60 for Chevron, ConocoPhillips (COP), Royal Dutch Shell (RDS/B), and BP (BP). Brent finished on Friday at $45 a barrel.
Shares of Exxon remain disliked by some analysts, but they could be near a bottom, as they trade for a small premium to book value. If Exxon is right and demand for fossil fuels continues to rise over the next 20 years, the company could be in a great position in a few years, having higher production and gaining market share from its rivals.
Chevron, whose shares are off 21% this year, to $95, covers its dividend more comfortably. It now stands at 5.4%.
Next to energy, financial stocks have been the worst performers in the stock market this year, as investors anticipate weaker bank earnings. The sharp drop in rates is the main culprit, pressuring net interest margins.
Bank earnings could be lower in 2020 than in 2019, but that is reflected in the stocks, which are down an average of 25% so far this year. With the decline, some banks like Wells Fargo, whose shares are off 30% this year, to $37, and Comerica (CMA), at $45, yield over 5%. Other major banks, including JPMorgan Chase (JPM), Bank of America (BAC), and Citigroup (C), yield about 3%.
“We believe bank dividends are safe,” Jason Goldberg, the Barclays banking analyst, emailed Barron’s on Friday. “While bank earnings will be adversely impacted by the sudden drop in interest rates, it is important to note that the industry enters this period of uncertainty from a position of strength, with record capital and liquidity and benign asset-quality trends.”
Banks, he notes, are subject to a far more adverse economic and financial scenario in the annual stress tests administered by the Federal Reserve than what’s likely from the coronavirus. The extreme stress scenario envisions an 8% drop in gross domestic product from peak levels and a 10% unemployment rate, against 3.5% in February.
The Wells Fargo yield is very safe,” Jamison says. “The new CEO [Charles Scharf] will clean house. It’s a great franchise, and it will become more consumer friendly.” A major mortgage lender, Wells Fargo should also benefit from the drop in rates.
AbbVie, which is due to complete its merger with Allergan (AGN) in the coming months, trades around $89 and yields 5.3%, among the highest dividends in the drug group. It has a comfortable payout ratio of about 50%, based on its projected 2020 earnings of about $9.67 a share.
Dow, the chemicals producer, has been hit hard along with other economically sensitive stocks, falling 29% this year, to $40. It yields 7% and has a high payout ratio of 81% based on projected 2020 earnings of $3.49 a share. Dow is committed to what it calls an “industry-leading dividend.” Howard Ungerleider, its president and chief financial officer, called it the company’s “No. 1 priority” for free cash flow on an earnings conference call in January.
AT&T, whose shares at $37 yield 5.6%, has a manageable payout ratio below 60%. The company is sufficiently comfortable with its outlook to increase its share repurchase program under pressure from activist hedge fund Elliott Management.
Altria, known for its Marlboro cigarettes, has taken a write-down of about 60% on its Juul Labs stake, but that shouldn’t affect its ability to pay the dividend. At $43, Altria now yields 8%. The company takes its dividend very seriously. It has lifted it 54 times in the past half-century, including a 5% increase last year.
The top U.S. cigarette maker targets an 80% dividend payout ratio. Given the high yield, some investors would like to see Altria forgo a dividend increase this year or raise the quarterly payout—now 84 cents—by just a penny to buy back more stock.
Like other life insurers, Prudential Financial has been hit by the decline in interest rates, which may pressure earnings as maturing bond holdings need to be reinvested at lower yields. The company has one of the highest yields of its peers and a comfortable payout ratio of under 40%. Its shares, at about $70, yield over 6%.
Investors can also play high-yielding stocks through many ETFs, including the Vanguard High Dividend Yield (VYM), SPDR S&P Dividend (SDY), and Schwab US Dividend Equity (SCHD), all yielding more than 3%.
Many investors now prefer lower-yielding stocks with safer dividends, but there is still a place for high yielders if investors are selective in their choices.
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