Investors seeking yield at a time of potentially negative interest rates can find some refuge in dividend-paying stocks. Well, not all of them.
In a low-rate world, equity investors need to be prudent—snobby, even—about their yield allocations. If there’s a recession, a utility is probably a better bet than a highly cyclical stock.
Or maybe the Federal Reserve, which has cut short-term rates twice since late July, will forestall a recession. That scenario favors more sectors and companies as the economy continues to chug along.
One sector that faces headwinds in either scenario is financials, their solid fundamentals notwithstanding. When interest rates are low, banks in particular have to deal with a lower spread between what they earn on their assets and pay on their liabilities. That pressures their net-interest margins and, potentially, their ability to maintain dividend levels.
In any case, yields are already historically low across various asset classes, and not all dividends are alike. The S&P 500 index (.SPX) yields about 2%—higher than the 1.54% on the 10-year U.S. Treasury note.
An easy solution is to find some high-yielding stocks, but they can be vulnerable to dividend cuts, as was the case earlier this year with Kraft Heinz (KHC). The food company, which has been struggling with changing consumer tastes, slashed its dividend in February.
It’s crucial, therefore, to find stocks whose dividends are reasonably safe and likely to grow, even in a slowing economy or worse.
Barron’s found five such stocks. These companies, listed in the accompanying table, have kept their dividends intact and growing. Past is not always prologue, but a long track record of boosting payouts is a good starting point.
Nick Getaz, co-manager of the Franklin Rising Dividends fund (FRDPX), says that consistent dividend growth is often an “indicator of a very strong business model and typically a resilient one.”
To come up with the list, Barron’s started with the S&P 500 Dividend Aristocrats, all 57 of which have increased their dividends for at least 25 straight years.
The next step was to incorporate a system that measures dividend safety developed by Reality Shares, an index provider.
Besides giving stocks an individual score for how safe a particular dividend looks, the methodology confers a rating of one to five on every stock it analyzes; five is the highest, and one, the lowest.
Of the seven Dividend Aristocrats that had a dividend safety score of five, two were discarded from the list because their yields were below the S&P 500’s average. The omissions were Cintas (CTAS) and S&P Global (SPGI).
That left five Aristocrats, the largest of which in terms of market capitalization is health-care company Johnson & Johnson (JNJ). It sells pharmaceuticals, consumer products, and medical devices.
“We’ve always considered Johnson & Johnson to be a very high-quality, diversified health-care name,” says Getaz, who holds the stock in the fund that he co-manages.
The consensus FactSet 2019 profit estimate for J&J is $8.62 a share, up about 5% from the $8.18 it earned last year.
The stock, which yields 2.8%, has a one-year return of about minus 1%.
At first glance, Nucor (NUE), which makes steel and various products such as pipes and fasteners, may not appear to be the best dividend play, given its cyclicality.
Nevertheless, the company, whose stock yields 3.2%, has increased its dividend since it began paying one in 1973. Its most recent boost occurred last November, when it declared a quarterly dividend of 40 cents a share, up from 38 cents.
Getaz describes Nucor as a “very high-quality steel producer, but at the same time, it is a commodity-driven business.”
Still, the company has been able to earn money in up and down markets “and remains well positioned to sustain consistent profitability,” according to Andrew Lane of Morningstar.
Matthew Miller, an analyst at CFRA Research, noted recently that “2018 is likely to be peak earnings for this economic cycle, as steel prices have moderated.”
Its FactSet consensus profit estimate for this year is $4.54 a share, down from $7.64 in 2018. It’s expected to pay dividends of $1.60 a share, or 40 cents per quarter, this year. Even with all of the volatility of steel prices, the company continues to cover its dividend—that is, its earnings exceed the dividend.
Another company on the list is Illinois Tool Works (ITW), a diversified manufacturer whose products include braking systems and food-processing equipment. Its exposure to the auto industry has been a concern—though its one-year return is about 11% and bests the S&P 500’s 4% result.
Last year, Illinois Tool Works paid dividends of $3.56 a share on earnings of $7.60 for a reasonable payout ratio of a little less than 50%. Even though the consensus shows earnings going up only slightly this year, to $7.64, the dividend is on track to hit $4.13—helped by estimated free cash flow of about $2.5 billion, according to FactSet.
The company has raised its dividend for 47 straight years.
The remaining two companies on the list are Pentair (PNR), a water company with products such as swimming-pool pumps, and W.W. Grainger (GWW), a distributor of maintenance, repair, and operating supplies.
Both stocks yield about 2%, and these firms have each boosted their dividends for more than 40 consecutive years.
The consensus 2019 estimate for Pentair is $2.33 a share this year, down by two cents from last year, and $2.57 in 2020.
Grainger is expected to grow faster in the short run, with earnings of $17.58 a share this year, compared with $16.70 in 2018.
Pentair and Grainger, however, both easily covered their dividends last year, and their payout ratios are a reasonable 37% and 33%, respectively.
These two companies, along with Nucor, Pentair, and Johnson & Johnson, look like they have dividends that can withstand tougher economic times or low interest rates for a sustained period.
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