Your Money: Dividend-paying stocks offer alternative to fixed income
By Erin E. Arvedlund
We’re at a strange inflection point in the capital markets. For decades, yields on fixed-income securities such as U.S. Treasuries have been falling, and they have reached a historic low point because the federal government has been intervening in its own debt markets.
Leaving aside whether it’s a good idea for the Federal Reserve to buy Treasuries, the yield on the 10-year Treasury, for instance, is now less than 3 percent. As a result, there are very few places for investors like us to find a place to generate income in our portfolios.
Strange, but it turns out stocks might actually yield more than bonds. Enter dividends into the portfolio picture.
We sat down with a portfolio manager in dividend-yielding equities last week to figure out how some stocks are yielding more than 3.5 percent, while 10-years are yielding less than 3 percent. Donald G. Taylor is portfolio manager for Franklin Equity Group in Fort Lee, N.J., part of a team that manages several funds, including Franklin Rising Dividends Fund, Franklin Rising Dividends Securities Fund, and Franklin U.S. Rising Dividends Fund.
We don’t endorse particular mutual funds, since many carry expensive sales loads (or front-end sales charges paid when first investing). And with annual management fees above 1 percent, mutual funds are often not worth the bother, since many don’t outperform the broader stock market.
However, it is useful to look at the underlying stocks in those dividend-yielding portfolios. Some of Taylor’s holdings include IBM, Procter & Gamble, PepsiCo, Wal-Mart, Abbott Laboratories, Johnson & Johnson, McDonald’s, Dover Corp., Becton Dickinson in Franklin Lakes, N.J., and Air Products & Chemicals in Allentown.
Some picks are based on screen-sorting, looking out for companies that have increased their dividends for at least eight of the last 10 years, have a history of high cash flows, and generate a regular source of income for their shareholders.
Remember, you can always go out and buy these stocks yourself, without buying a mutual fund.
Taylor first bought a position in Becton Dickinson in 1996, when the dividend was 8 cents a share, or about 1.8 percent dividend yield. Becton Dickinson has a history of 38 years of annual dividend increases, and, Taylor said, next month the dividend will be raised from $1.64, or a 2.2 percent yield, to $1.80 a share, or 2.4 percent. Compounded over the long term, he said, the dividend increases plus the increase in share price from $19 to $74 today equal an 8.6 percent yield on the cost basis of the stock.
His biggest holding is IBM, which Taylor called “the rare technology company that figured out as early as the 1990s that dividends had a place in investors’ hearts. Management under Lou Gerstner realized that computer hardware was at risk, and they moved to software and services.”
Taylor wishes more high-tech companies would institute dividends, which would persuade more shareholders to stick around when downturns occur.
“When tech companies grow, investors over-extrapolate growth. But when the cycle turns, the stocks get hit,” he said. “IBM, on the other hand, has slower organic growth, but it’s more consistent.”
Giants such as Microsoft and Apple have been “unsophisticated about paying dividends,” Taylor said. “They have tremendous cash flow. They don’t need more acquisitions. And they don’t do buybacks. So why keep the cash in the bank?”
He argued that those companies should start paying dividends and attract a whole new set of shareholders.
Drug companies also find a place in his portfolios, including Abbott Laboratories (3.64 percent dividend yield) and Johnson & Johnson (3.52 percent yield).
“Pharmaceuticals are only elements of what they [Abbott and J&J] do, rather than Merck or Pfizer, which are more pure pharma,” according to Taylor.
As for local dividend-payers such as Air Products, Taylor said it has “had double-digit dividend growth” and has paid a dividend for more than 20 years.
Finally, Taylor also owns Family Dollar Stores, which is benefiting from a middle class trading down from higher-priced stores because of the weak economy.
His own father has been investing in five-year rollover CDs. But, Taylor explained, “They’re running out of yield, too. There’s no income in fixed income these days. Much of the equity market is in a position to meet an unmet need, especially if interest rates stay low until 2013.”