Bond yields are generally too low now to attract traditional investors, so income-oriented investors have look for yield in stocks and other instruments. And with all the credit rating cuts and warnings, high dividend-paying stocks may actually be more attractive than sovereign debt and Treasuries paying only about 2% for ten-years. 24/7 Wall St. is releasing its 2012 Model Dividend Portfolio.
The stock market often overlooks many high-yield stocks when the broader market sells off. Yet, in some cases, half of an investor’s return through time may come from dividends. Warren Buffett generally picks dividend-paying companies for Berkshire Hathaway Inc. (NYSE: BRK-A) after following some of the principles of Benjamin Graham.
24/7 Wall St. has made many changes to its 2012 Model Dividend Portfolio. Some changes are because of price, and some are based on new outlooks for 2012 and beyond. The 24/7 Wall St. 2012 Model Dividend Portfolio includes the following stocks: American Electric Power Co., Inc. (NYSE: AEP); American Water Works Company, Inc. (NYSE: AWK); AT&T, Inc. (NYSE: T); ; General Electric Co. (NYSE: GE); Government Properties Income Trust (NYSE: GOV); Kimberly-Clark Corporation (NYSE: KMB); Senior Housing Properties Trust (NYSE: SNH); and Wal-Mart Stores Inc. (NYSE: WMT).
We have not avoided Real Estate Investment Trusts (REITs) as a class, although those double-digit risky yields in some REIT sectors have been avoided. While we usually avoid exchange-traded products for our model portfolio picks, the recent trends currently lend some merit to look at the open-end or closed-end mutual funds in the high-yield, MLP, and preferred sectors for income investors as we move from 2011 to 2012.
THE 24/7 WALL ST. 2012 MODEL DIVIDEND PORTFOLIO
American Electric Power Co., Inc. (NYSE: AEP) may be near a multi-year high, but this shareholder-friendly utility remains a top pick in a sector that is no longer looking so cheap. Utilities are now the new replacement for certificates of deposit (CDs) for retirees. Shares of this great company trade around $39.25, the 52-week trading range is $33.09 to $40.08, and the dividend yield is roughly 4.9%. American Electric Power just raised the dividend in November, so the current payout will likely be in place through most of 2012. The low interest rate climate helps utilities and the company is active in lobbying against many regulatory pressures that would be both bad for investors and would act as a tax on consumers. The company has a great mix of power assets, and it covers millions of Americans in many states.
American Water Works Company, Inc. (NYSE: AWK) is the top water utility for investors and is suitable for almost all investment portfolios. The company has a great geographic footprint, covering millions of Americans in many states. Water Works will benefit from the low long-term interest rates, and the stock almost never sells off 10% from its highest share price. At $31.00, the 52-week range is $24.60 to $31.80. While it is not cheap, analysts value the stock at $44, and it remains a premium holding. Its dividend yield is now slightly under the 3% mark, but we expect another dividend hike next summer. Our view is for the stock to climb to the mid $30s into late 2012 or early 2013, but Gabelli & Co. has a private market value of $44 per share on this great water utility.
AT&T, Inc. (NYSE: T) is currently on sale due to the huge breakup fee it will likely have to pay if the T-Mobile acquisition fails. Shares trade around $28.90, and the 52-week range is $27.20 to $31.94. Despite the iPhone going elsewhere, AT&T is cheap and its dividend payout ratio is far less than that of rival Verizon Communications Inc. (NYSE: VZ). AT&T is now the king of the DJIA dividends at 5.9%, and it may soon be raising its payout again. The consensus price target is almost $32.00, leaving 10% upside in the stock plus that near-6% yield.
General Electric Co. (NYSE: GE) remains our favorite conglomerate with its valuation of less than 11-times expected earnings and a 3.7% dividend yield. GE may even hike its dividend by mid-2012. At $16.25, the 52-week range is $14.02 to $21.65, and analysts still have a price target close to $21.00. CEO Jeff Immelt remains extremely happy with the company’s investment portfolio, and GE looks less and less like a bank and consumer lending firm each quarter. GE’s value is solid when compared to conglomerate peers, and the dividend is higher than other conglomerates as well. GE is not just one of the 2012 Model Dividend Portfolio picks, it is also a pick for value investors who are also looking for potential upside above the S&P 500 Index giants.
Government Properties Income Trust (NYSE: GOV) is how investors can make the government pay out a 7.7% dividend yield when government bonds barely pay 2% for ten years. It is a REIT whose almost all of its tenant clients are federal, state, and local government entities under long-term leases. REITs should win from a low-interest rate environment, and we believe fears grew too much here in this particular REIT during the austerity and budget gap talks of the summer. At $21.50, the 52-week range is $19.68 to $27.80, and it trades at about 1.1-times book value and less than 11-times expected earnings (FFO for REITs).
Kimberly-Clark Corporation (NYSE: KMB) is a great shareholder-friendly company in the world of consumer products. It has been able to thrive in good times and hard times. At $69.85, its 52-week range is $61.00 to $73.23, and its dividend is right at 4%. Kimberly-Clark shares offer both yield and safety, and we are looking for a dividend hike yet again in early 2012. At 13-times expected earnings, it can still likely get closer to $80 a share over the intermediate to longer-term after its dividend payout. Commodity costs are usually a concern in the consumer products sector, as are higher in-store promotion costs. Still, the company and the stock have been able to grow and hold up during hard times.
Senior Housing Properties Trust (NYSE: SNH) is in the sweet spot of taking advantage of growing numbers of retirees as it owns and operates assisted living facilities, senior homes, and nursing homes. The REIT has managed to avoid the reimbursement woes, something for which its investors have been thankful. The stock trades at about $21.30, the 52-week range is $19.09 to $24.66, and it trades at less than 12-times expected earnings (FFO). The current market cap is about $3.5 billion. This REIT is helping investors in making money off retirees because of its 7% dividend, and the consensus price target is at $24.25. Management has done well by avoiding the pure government-dependent markets in healthcare and senior care. The company just raised its payout in October, so another hike is not expected until late in 2012.
Wal-Mart Stores Inc. (NYSE: WMT) is the king of retail with over $100 billion in sales per quarter. Its stock is also at the high-end of its decade-long trading range with shares around $58.00. The stock may finally be able to form a chart breakout after it did not sell off much on its recent mixed earnings. If the consumer is going to be in a pinch again in 2012, Walmart is supposed to be the winner among large retailers. Walmart has the lowest dividend yield of our 2012 Model Dividend Portfolio, but at 2.5% it effectively has the highest yield of most retail stocks. Walmart is a defensive stock now, trading under 12-times expected earnings. The next dividend hike should come in the March 2012 payout, and Walmart has been buying back stock. This is now about a company not needing its cash for cap-ex so it can return it aggressively to its shareholders rather than invest in further growth. With analysts only valuing Walmart’s consensus price target around $61.45, investors may want to try to buy when shares experience pullbacks.
MLPs & HIGH-YIELD FUNDS
24/7 Wall St. generally tries to avoid mutual funds and exchange-traded products for its Model Dividend Portfolios because some can have tracking errors when they “track” rather than hold them. Also, some can have wild swings in their share prices some investors seem to not understand. There are dozens of closed-ends funds and even more open-ended funds that track two sectors that yield-hungry investors need to consider: MLPs and junk bonds. Both offer high payouts, but they are often somewhat insulated against against days of extreme volatility in the stock market.
Call it junk bonds, or call it high-yield bonds, but the sector offers incredibly high interest payments in the form of dividends if they are in mutual funds or in exchange-traded products. While defaults rise during a recession, by and large they have not exceeded the debt payments in any years in recent history (including the recessions after 9/11 and most recently). The trick is to know what you are investing in and to know which high-yield (or junk) funds invest in risky corporate debt and which invest internationally in risky sovereign or agency paper.
Why invest junk bonds during times of uncertainty? Junk bonds have recently traded at spreads over equivalent Treasury yields wider than 700 basis points (7%). With Treasury notes barely paying 10% for ten years, high-yield bonds give investors 7%, 8%, and even 9% more in yields.
The SPDR Barclays Capital High Yield Bond (NYSE: JNK) aims to track the price and yield performance of the Barclays Capital High Yield Very Liquid Index. Its advisors also have some room to invest in ‘similar securities.’ While it can have a tracking error, this exchange-traded product has become extremely liquid with more than 5 million shares trading per day. This ETF also offers a yield of close to 8%. There are many closed-end funds investing in junk bonds, and this ETF can be used as a substitute or it can be used as a hedge with stock options for many of those closed-end funds. Some of the many closed-end funds in the high-yield bond sector are managed by large firms such as BlackRock, FirstTrust, Helios, MFS, Nuveen, PIMCO, and Western Asset Management.
Not many investors are aware of the world of Master Limited Partnerships, or MLPs. Many just think of these as high-yield oil companies. The payouts are high, but these companies generally own pipelines, storage facilities, and terminals in the oil and gas sector. Think of them as “the toll roads and utilities” of oil and gas. Investors have to consider tax consequences when investing in MLPs in many cases because the payouts are not always just dividends. The payouts can vary between income payouts just like dividends, but there is usually a return of capital component that is often not taxed.
There are two key ETF products in the world of MLPs, both of which are liquid and have high payouts. JPMorgan Alerian MLP Index ETN (NYSE: AMJ) and ALPS Alerian MLP ETF (NYSE: AMLP) are two key exchange-traded products for investors in this sector. The two pay over 5% and over 6% in “payout rates,” respectively. There are often opportunities in the closed-end funds for discounts and premiums to net asset values, and that is generally where higher dividend-equivalents can be found.
Both of the above exchange-traded products have stock options that can be used for hedging the many closed-end funds out there tracking MLPs. Some of the fund families that manage closed-end (and some open-end) mutual funds are Kayne Anderson, Tortoise, and ClearBridge. These can fluctuate in a different manner versus an index, but they can easily be hedged with options tracking the exchange-traded products above.
A RUNNER-UP IN FINANCIALS… PREFERRED SHARES
24/7 Wall St. has not selected a single financial stock for the model dividend portfolio for many reasons. Financial firms are exposed to sovereign debt rating risks in their investment portfolios, ongoing regulation changes, possibly endless law suits, and a lack of clear earnings power. The world of preferred trust securities is generally far safer than picking an individual bank stock these days. For “widows and orphans” investors, trust preferred securities have historically provided much less risk than common stocks because the price volatility is generally far lower than the underlying stock market and bank stock sector. Preferred trust securities have high yields, and are also generally higher in the payout line should defaults and bankruptcies ever arise.
The PowerShares Financial Preferred (NYSE: PGF) aims to track the the price and yield of the Wells Fargo Hybrid & Preferred Securities Financial Index, and it invests at least 90% of total assets in preferred securities of those in that index. The current holdings as of December 2012 were HSBC, ING, BofA, J.P.Morgan, Wells Fargo, MetLife and others. How many bank securities pay 7% in dividends these days? And it is much less volatile than the underlying banks’ common stocks. It trades at $16.35 and its 52-week range is $14.70 to $18.45.
THE EXITS FROM THE MODEL PORTFOLIO FOR 2012
24/7 Wall St. has consistently made adjustments to its dividend portfolios. This year has been an incredible year for those investors who have sought safety rather than aggressive growth., We made several changes from our traditional dividend portfolios because of the price performance of some of our favorites. If price parameters get too expensive, why chase endlessly?
We removed the following from our 2012 Model Dividend Portfolio: Altria Group Inc. (NYSE: MO); Digital Realty Trust Inc. (NYSE: DLR); Enterprise Products Partners LP (NYSE: EPD) and Kinder Morgan Energy Partners LP (NYSE: KMP). We have given a brief description on each below, as well as what changed to remove the stock from the model portfolio.
Altria Group Inc. (NYSE: MO) has outperformed our top expectation, and we are just not willing to chase the domestic tobacco stock endlessly with a 5.8% yield. Smoking volumes are on the decline. In addition, the potential fallout from ever increasing taxes and from incredibly unfavorable packaging simply do not create any comfort that earnings and payouts will rise at the same rate of the last decade. We have not decided to look at other tobacco shares either. This could be the zenith of that sector.
Digital Realty Trust Inc. (NYSE: DLR) has long been a favorite of 24/7 Wall St. due to its high dividend of 4.3%. We consider it “The Landlord of Technology and the Cloud.” With shares above $64.50, it has surpassed our internal maximum target of $62.00, and the price parameter would have to get back down to $58.00 or so before being reconsidered for inclusion in the Model Dividend Portfolio again. Digital Realty is a great REIT, but now also an expensive one. For investors wanting a big dividend in technology, perhaps Intel Corporation (NASDAQ: INTC) can be considered as a substitute on days when its shares have sold off. It was good enough for Warren Buffett in his most recent holdings. We have not included Intel in our Model Dividend Portfolio, but we would consider adding it to the portfolio if shares sell off.
Enterprise Products Partners LP (NYSE: EPD) and Kinder Morgan Energy Partners LP (NYSE: KMP) have been replaced as the two go-to individual MLP income products due to their price performance. Both have performed above our expectations and now trade above the published consensus analyst price targets. We now prefer the ETFs or closed-end funds in these sectors that include many of the smaller partnerships.
JON C. OGG