Why the Bluest Blue Chips Rule This Market

Investors flock to dividend-paying stocks for safety and income

Large, dividend-paying stocks were among the best performers in 2011, and analysts and money managers say they are positioned for another strong showing this year. The 10 highest-yielding stocks in the Dow Jones industrial average as of Jan. 1, 2011—the so-called Dogs of the Dow—returned 17.2 percent, dividends included, over the course of the year, 15 percentage points better than the broad market’s total return.

This year, concerns over Europe’s debt crisis and related global market volatility will have more investors turning to blue-chip dividend stocks for their relative safety, says Matthew D. McCormick, a principal at Cincinnati-based money manager Bahl & Gaynor Investment Counsel. Investors are “unlikely to take an undue amount of risk,” he says. “If they’re going to be in stocks, their thinking will be the bigger, the bluer, the better—and why not get paid for it?”

In his most recent client letter, fund manager Jeremy Grantham credited his faith in well-capitalized, cash-rich large-cap stocks for the gains in his GMO Quality Fund, which ended the year up 12 percent. “We would normally count on winning in this strategy in a big down year,” he wrote, “but in a nearly flat year this difference is a testimonial to how risk-averse investors have been at the U.S. stock level.”

Dividends offer more than safety: With interest rates at record lows, they also are one of the few attractive sources of income. While 10-year Treasury bonds closed the year yielding less than 2 percent, the average dividend yield for stocks in Standard & Poor’s 500-stock index was 2.08 percent at yearend, and the 10 highest yielders in the Dow averaged 3.96 percent. At the top of the list, AT&T yielded 5.8 percent, while No. 10 Kraft yielded 3.1 percent. Companies in the S&P 500 will raise dividends by 11.5 percent on average this year, according to a Bloomberg Dividends forecast. “All my high-net-worth clients are looking for nothing more than a stable cash flow,” says Joshua Scheinker, a senior vice-president with brokerage Janney Montgomery Scott. “They want a high-quality portfolio with a focus on ‘income, income, income.’ I will take P&G, 3M, Pepsi, AT&T, and Intel over fixed income any day.”

Even Pimco, the world’s largest bond manager, sees the appeal of dividend-paying stocks. Pimco started the year by launching two new dividend-focused equity funds: Pimco EqS Dividend Fund and the Pimco Dividend and Income Builder Fund. Pimco has a lot at stake: Last year its flagship bond fund, the $244 billion Total Return, suffered from its first calendar year of net redemptions since it opened in 1987. Of Pimco’s $1.35 trillion in assets, only $5 billion are in stock funds.

Investors who buy big U.S. companies are getting strong earnings prospects at a reasonable price. Earnings for companies in the S&P 500 have beaten analysts’ estimates for the past 11 quarters and are forecast to climb 10.7 percent, to $105 a share in 2012, according to data compiled by Bloomberg. Stocks in the index trade at 13.5 times reported earnings, compared with 15.8 in February and an average of 16.4 since 1954, the data show. The 50 largest U.S. companies by market capitalization are trading at about 10 times expected earnings for the coming year, according to Jun Zhu and Andrew J. Engel, analysts at investment firm Leuthold Weedon. They say that dividend-payers in that group such as Johnson & Johnson and Kraft could see their price-earnings ratios rise this year as safety-minded investors flock to them.

Kate Warne, the investment strategist at Edward Jones, says that dividend-paying large caps will get another boost as investors get over the losses they suffered in 2008 and 2009, when a record number of financial companies slashed their payouts and their share prices plunged. “They’ll realize they cannot just throw out the strategy because of 2008,” she says. “The dividend trend will have the wind to its back, and will be necessary for them to build wealth over time.”


    The bottom line: Stocks in the S&P 500 are forecast to boost profits by 10.7 percent this year and trade at 13.5 times reported earnings.

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