S&P's Smartest Dividend Plays

Looking for solid, high-yielding names? Here is S&P's selection of stocks and ETFs that fit the bill

In the past few weeks, I have received inquiries about the benefits of investing in high-dividend-paying stocks. So I thought I would share with you some of my thoughts and screens.

While fear and greed are the two emotions that propel share prices in the near term, earnings and dividends drive them in the long term. Investors look to earnings growth for their indirect benefit to returns, as higher earnings usually increase share prices. Unfortunately, you have to sell the stock in order to turn paper profits into real ones. Dividends are received without having to sell out, thus making them more attractive to the income-seeking investor. In addition, dividends can offer investors a bit of emotional support, as they offset share-price declines up to the value of the dividend yield.

Slowing Expansion

Anecdotal evidence shows that investors typically gravitate toward low-dividend payers early in the stock market cycle, since they are typically represented by smaller, more volatile issues whose earnings growth (and therefore share prices) will likely grow more rapidly as an embryonic economic expansion gets underway. As economic growth is projected to decelerate, however, higher yielders are usually favored as investors are "paid while they wait" during a period of less-certain earnings growth.

In our opinion, the economic expansion and bull market are getting a bit long in the tooth. The U.S. economic expansion started in November, 2001, more than 66 months ago—the typical expansion since 1945 has lasted an average of 60 months. The current bull market started in early October, 2002, and is now almost 57 months old—three months older than the average since World War II. Finally, S&P equity analysts project operating earnings growth for the S&P 500 to decelerate, rising 7.3% in 2007 versus a 14.7% advance in 2006.

If an investor wanted to seek out high-dividend yields, where in the universe of S&P large-, mid-, and small-cap indices should he look?

The exchange-traded fund (ETF) investor would be well advised to look toward large-cap issues, value styles, and defensive sectors. As seen in the accompanying table, the large cap S&P 500 offers the highest yields among the three U.S. stock market benchmarks at 1.8%. Within all three size categories, the value components offer a yield that is from 55% to 81% above their respective benchmarks.

Relatively high yields, therefore, favor the following non-exhaustive list of ETFs: iShares S&P 500 Value Index Fund (IVE; $66; 1.9%), Rydex S&P 500 Pure Value Trust (RPV; $37; 2.3%), iShares S&P Midcap 400 Value Index Fund (IJJ; $71; 1.7%), Rydex S&P Midcap 400 Pure Value Trust (RFV; $37; 2.4%), iShares S&P SmallCap 600 Value Index (IJS; $65; 1.1%), and Rydex S&P Smallcap 600 Pure Value Trust (RZV; $44; 1.6%). Let's not forget SPDR S&P Dividend (SDY; $62; 3.0%), the S&P Dividend Aristocrats ETF.

On a sector level, high yields are found in large-cap Consumer Staples Select Sector SPDR Fund (XLP; $27; 2.1%). Across-the-board, above-average yields are also found in Financial Select Sector SPDR Fund (XLF; $37; 2.3%) and Rydex S&P Equal Weight Financial ETF (RYF; $52; 1.2%)—an equal-weighted S&P 500 sector fund with return characteristics similar to mid- and small-cap stocks. Other noteworthy names come from the utilities sector: Utilities Select Sector SPDR Fund (XLU; $39; 2.8%) and Rydex S&P Equal Weight Utilities ETF (RYU; $62; 1.6%).

For those investors who prefer individual issues, here are two ways to search for high-yielding equity candidates. First, look for those S&P 500 subindustries with positive S&P analysts' fundamental outlooks that contain 4- and 5-STARS stocks: Tobacco: Altria Group (MO; 5 STARS; $69; 4.0%); Other Diversified Financial Services: Bank of America (BAC; 5 STARS; $49; 4.5%), Citigroup (C; 5 STARS; $52; 4.0%), and JPMorgan Chase (JPM; 4 STARS; $49; 3.0%); Pharmaceuticals: Bristol-Myers Squibb (BMY; 5 STARS; $31; 3.5%) and Merck (MRK; 4 STARS; $49; 3.1%); Soft Drinks: Coca-Cola Co. (KO; 4 STARS; $52; 2.6%) and PepsiCo (PEP; 4 STARS; $65; 2.3%); and finally, Integrated Oil & Gas: Chevron (CVX; 4 STARS; $82; 2.8%).

Another way to search for high yielders is to use S&P's Advisor Insight equity research delivery service to screen for candidates. Using STARS ranking of 4 or 5 and a yield in excess of 3%, I came up with (besides the companies already listed above) these non-REITs: American Capital Strategies (ACAS; 5 STARS; $44; 8.2%), Citizens Communications (CZN; 5 STARS; $15; 6.6%), Lloyds TSB Group (LYG; 5 STARS; $45; 5.8%), NICOR (GAS; 5 STARS; $44; 4.2%), Regions Financial (RF; 5 STARS; $34; 4.2%), and Wachovia (WB; 5 STARS; $52; 4.2%).

So there you have it. There are plenty of investment techniques available, one of which focuses on high yields. But don't let a pretty face fool you. Sometimes if the yield looks too good to be true, it probably is. The following companies have high yields but low S&P STARS (possibly for non-dividend-related reasons): Alaska Communications Systems Group (ALSK; 2 STARS; $16; 5.5%), Enbridge Energy Partners (EEP; 2 STARS; $56; 6.6%), Ferrellgas Partners (FGP; 2 STARS; $24; 8.3%), General Maritime (GMR; 2 STARS; $28; 6.4%), Magellan Midstream Partners (MMP; 2 STARS; $46; 5.5%), NuStar Energy (NS; 2 STARS; $67; 5.4%), Ship Finance (SFL; 2 STARS; $30; 7.4%), Thornburg Mortgage (TMA; 1 STARS; $27; 10.0%), Tomkins (TKS; 2 STARS; $21; 5.1%), and Washington Mutual (WM; 2 STARS; $43; 5.1%).

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of 5 (price performances in the past 12 months that were among the top 10% of the 136 sub-industries in the S&P 1500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).

Subindustry Company S&P STARS Rank Price (6/22/07)
Apparel, Accessories Quiksilver (ZQK) 5 $14
Commercial Printing R.R. Donnelley (RRD) 4 $42
Commodity Chemicals Lyondell Chemical (LYO) 3 $38
Computer Hardware Apple Inc. (AAPL) 4 $123
Construction & Engineering Jacobs Engineering (JEC) 5 $57
Construction Materials Vulcan Materials (VMC) 2 $118
Consumer Electronics Harman Intl. (HAR) 4 $117
Diversified Metals & Mining Freport-McMoRan Copper (FCX) 3 $83
Fertilizers & Agr. Chem. Monsanto (MON) 3 $68
Internet Retail Amazon.com (AMZN) 2 $69
Metal & Glass Containers Ball Corp. (BLL) 4 $54
Steel U.S. Steel (X) 3 $113
Technology Distributors Arrow Electronics (ARW) 3 $40
Tires & Rubber Goodyear Tire (GT) 2 $35
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