Income-seeking investors have long had a difficult time, given that interest rates have been so low for so long. And with bond yields falling even more this year than many people thought possible, the resulting flight to yield and safety has pushed prices of many dividend stocks to lofty levels.
But it's still not too late to consider dividend stocks — if you really need the income.
As you can see in the table to the right, the two S&P 500 (.SPX) sectors that have risen the most so far this year are telecommunications and utilities, which are well-known for high concentrations of stocks with high dividend yields. Katie Nixon, the chief investment officer at Northern Trust Wealth Management, recently described investors' clear preference for dividend stocks and high-yield bonds this year, and warned that investors' psychology can "make you do things at precisely the wrong time."
This is especially important, because many professional investors and advisers are warning that total returns on stocks with high dividend yields are likely to be low for the next few years, not only because of the run-up in prices this year, but because the Federal Reserve may soon resume raising interest rates.
All things being equal, when interest rates go up, prices of income-producing securities go down, and vice versa.
But there's something missing from the warnings. They focus on total return, or your total gain when you sell the investment, assuming you have reinvested your dividends.
If you really need income, you're not reinvesting the dividends.
Instead, you are focused on having money coming in and are most concerned about the risk that the payout will be cut. You are willing to tolerate market-price fluctuations as long as the dividend check keeps arriving like clockwork.
Panic selling is not for income-seeking investors.
There have been two declines of at least 10% in the S&P 500 over the past 12 months. Last August, investors were worried about a plunge in Chinese stocks and an expected change in interest-rate policy by the Federal Reserve, which had kept the federal funds rate in a range of zero to 0.25% since late 2008. The Fed raised the benchmark rate to a range of 0.25% to 0.50% in December, but hasn't made a move since.
Then early this year, the S&P 500 saw another major decline as economic data pointed to a possible U.S. recession. The numbers have since gone the other way, and the creation of 292,000 jobs in July points the way to another rate hike by the Fed this year, even as other central banks have pushed interest rates into negative territory.
No one knows when the stock market will have its next pullback. We only know that one will eventually happen, possibly driven by yet another round of hysteria over Fed policy.
3 stocks with favorable payout ratios
If and when rates rise, your dividend stocks may well lose market value. Prices may climb back relatively quickly, because overall interest rates will still be low. But if you are a serious income-seeking investor, you cannot be surprised by rate-driven volatility because you know it will happen.
How to avoid the dreaded dividend cut
What dividend-stock investors fear most is a dividend cut. That can wipe out tremendous value, while starving you of the income you sought in the first place.
If a dividend-paying company is increasing sales, earnings and cash flow, there's a pretty good chance it won't cut the dividend.
One way to measure a company's ability to cover and (hopefully) increase its dividend is to look at its free cash flow, or its remaining cash flow after planned capital expenditures. You can calculate the company's free-cash-flow yield by dividing the past 12 months' free cash flow by the current share price. If that yield is higher than the current dividend yield, the company has "headroom" to raise the dividend. Of course, it could choose to spend the extra cash flow in other ways, such as to fund organic expansion, buy back shares, make an acquisition or some other purpose.
To identify S&P stocks with headroom, we used data provided by FactSet to calculate free-cash-flow yields (based on the most current available reported numbers through Aug. 5) for those with dividend yields of at least 3%. We then pared the list to include companies that have paid dividends for at least five years, while excluding any company that had cut its dividend over the past 20 quarters.
Here are the 15 remaining S&P 500 stocks with the highest dividend yields:
|Company||Ticker||Industry||Dividend yield||Free cash flow yield - past 12 months||'Headroom'|
|Seagate Technology PLC||STX||Computer Peripherals||7.84%||11.34%||3.50%|
|HCP Inc.||HCP||Real Estate Investment Trusts||5.99%||8.04%||2.06%|
|Staples Inc.||SPLS||Specialty Stores||5.23%||9.89%||4.66%|
|Iron Mountain Inc.||IRM||Real Estate Investment Trusts||5.13%||5.29%||0.16%|
|Kohl's Corp.||KSS||Department Stores||5.09%||11.35%||6.26%|
|Ford Motor Co.||F||Motor Vehicles||4.92%||27.73%||22.81%|
|LyondellBassell Industries NV||LYB||Chemicals||4.56%||11.19%||6.63%|
|CenterPoint Energy Inc.||CNP||Electric Utilities||4.54%||4.89%||0.35%|
|Welltower Inc.||HCN||Real Estate Investment Trusts||4.50%||5.94%||1.44%|
|Valero Energy Corp.||VLO||Oil Refining/ Marketing||4.49%||13.55%||9.07%|
|Host Hotels & Resorts Inc.||HST||Real Estate Investment Trusts||4.48%||9.64%||5.16%|
|Helmerich & Payne Inc.||HP||Contract Drilling||4.43%||7.40%||2.97%|
|Macy's Inc.||M||Department Stores||4.43%||7.98%||3.55%|
|People's United Financial Inc.||PBCT||Savings Banks||4.39%||8.04%||3.64%|
Four of these companies are real-estate investment trusts. For this group, we used funds from operations (FFO) to calculate 12-month free-cash-flow yields. FFO is used by REIT investors to gauge dividend-paying ability. It adds depreciation amortization to earnings, while subtracting gains on sales of assets.
The purpose of this list is to provide some food for thought for income-seeking investors. Keep in mind that this is not a list of growth stocks. The idea is to receive steady dividends with a low likelihood of a dividend cut.
If you are considering one or more of these companies for long-term investments, the next step is to do your own research to consider their business strategies and prospects for success over the next decade. You should discuss these and other income possibilities with your broker or financial adviser.