Stocks: The Dividend Defense

Finding smart stocks with fat yields can help investors through a down market

In the past few weeks, I have received several inquiries as to how a retiree, or one who doesn't have a steady stream of new money to engage in dollar-cost averaging, could invest in today's market environment. The conversation frequently turned to high-dividend-paying stocks.

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, in this market environment, investors don't have a lot of confidence in today's earnings growth projections and, as a result, the Standard & Poor's 500-stock index recently tumbled into bear market territory. While investors should not deviate too much from their long-term investment plan, high-yielding stocks can offer both emotional and price support.

Anecdotally, investors typically gravitate toward low-dividend payers early in the stock market cycle, since they are usually represented by smaller, more volatile issues whose earnings growth and share prices are expected to rise more rapidly as an embryonic economic expansion gets under way. As economic growth is projected to decelerate, however, higher-yielding issues are usually favored as investors are "paid while they wait" during a period of less certain earnings growth. But if an investor wanted to seek out high-dividend yields, where in the universe of S&P large-, mid-, and small-cap indexes should they look?

The S&P 500 offers the highest yields among the three U.S. stock market benchmarks at 2.4%, vs. 1.5% for both the S&P MidCap 400 and SmallCap 600 indexes. Within these indexes, the Financials and Utilities sectors consistently offer higher-than-average dividend yields. But when you consider that much of the recent market sell-off has been in conjunction with investor concern over the safety of these dividend payments, it may be best to consider individual securities rather than sectors.

One exception, in our opinion, is the S&P Dividend Aristocrats ETF, which consists of the 60 companies in the S&P 500 that have increased their cash payments in each of the past 25 years.

High Yields and High STARS

As of the close of trading July 11, eight companies in the S&P 500 were paying a dividend yield in excess of 10%. In the S&P MidCap 400, three stocks were paying double-digit yields, while 11 in the SmallCap 600 yielded above 10%. Obviously, not all high-yielding companies are worth buying. As we have been told countless times, if something sounds too good to be true, it probably is.

Several companies that offer very high dividend yields have unfavorable investment recommendations under S&P's STARS (Stock Appreciation Ranking System). Using the stock screener capability on S&P's Advisor Insight, 33 index and nonindex companies offered dividend yields in excess of 5% that also had sell (2 STARS) or strong sell (1 STARS) recommendations by S&P analysts. Indeed, 13 of these sported double-digit yields.

The five highest-yielding non-REIT stocks with unfavorable investment recommendations were: Biovail (BVF, 14.8%), McClatchy (MNI, 14.1%), Wachovia (WB, 12.9%), Federal Home Loan Mortgage (FRE, 12.9%), and First Horizon National (FHN, 11.9%).

On the flip side of this screen, there were 50 stocks that yielded 5% or more with buy (4 STARS) or strong buy (5 STARS) recommendations by S&P equity analysts. The five highest-yielding non-REIT/nonlimited partnership stocks were: American Capital (ACAS, 16.6%), DHT Maritime (DHT, 14.4%), Lloyds TSB Group (LYG, 12.6%), Consolidated Communications Holdings (CNSL, 11.0%), and Sinclair Broadcast Group (SBGI, 10.8%). (For more names, see the accompanying slide show.)

So there you have it. Just because a stock is paying a very attractive yield doesn't mean it's a good investment. Using S&P equity analysts' investment outlooks to weed out the riskier issues may help investors navigate today's more challenging investment environment.

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 subindustries 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 Ticker S&P STARS Rank Price (7/11/08)
Biotechnology Genzyme GENZ 5 92
Brewers Molson Coors Brewing TAP 5 54
Coal & Consumable Fuels Peabody Energy BTU 4 95
Fertilizers & Agr. Chem. Monsanto MON 5 119
Gas Utilities ONEOK OKE 5 48
Gold Newmont Mining NEM 4 51
Home Entertainment Software Electronic Arts ERTS 3 44
HyperMarkets & Super Centers BJ's Wholesale BJ 4 40
Industrial Gases Airgas ARG 5 58
Oil & Gas Drilling Noble NE 5 59
Oil & Gas Equip. & Svcs. Superior Energy Services SPN 5 51
Oil & Gas E&P Swift Energy SFY 5 58
Railroads Norfolk Southern NSC 4 62
Steel Allegheny Technologies ATI 4 50

Source: Standard & Poor's Equity Research

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