For those who supply capital, the interest-rate nightmare continues and shows little sign of abating any time soon. These are great times if you’re borrowing, but it you want or need seeking investment/saving income, may be as bad as it gets. The only thing worse would be dividend reductions: Oh wait, given continuing uncertainties on the economic front (covid-19, an aging business cycle, brass-knuckle politics), that, too, is an ongoing concern. Investing smarts can’t cancel this, but there’s a lot you can do to make the best of it.
© Can Stock Photo / koya979
Step One — Manage Expectations
As one who started in security analysis when the bank prime rate was around 20% and even rates in that range weren’t good enough to induce savers to buy CDs (banks also gave free gifts such as toasters or even color TVs), I never thought I’d see the day when I’d have to say, as I do now, that if you can get a dividend yield north of 2%, that’s pretty good and above 3% is excellent. Sure there are stocks yielding around 10%, or more, but that’s only on paper and based on historic payments. The stocks are priced low (which causes the yields to look high) because the market expects those companies to reduce or eliminate dividends, and in this area, Mr. Market turns out to be right very often.
Step Two — Remember Why You’re Looking At Income Stocks As Opposed (Or In Addition) To Fixed Income
You absolutely can find higher yields in fixed income. Some of it is in high yield (junk) where credit risk is a problem. But even for good quality choices, fixed in come is, well, fixed. That means that if interest rates rise in the future, or even if investors start to anticipate future rate increases (maybe not tomorrow but with benchmark rates now around zero, this source of risk cannot be ignored), you’ll be stuck with deteriorating principal. At least with equities, you can expect companies to raise dividends.
Step Three – Consider Divided Security While risk of dividend cuts can never be eliminated, it can be mitigated through strategic choices to favor good stocks and strong companies.
Searching For Specific Equity-Income Ideas
I screened on On Chaikin Analytics using the following criteria:
- Start with a broad universe consisting of Russell 3000 stocks.
- The overall Chaikin 20-factor fundamental-technical Power Gauge rating should be Neutral or better: Usually, we focus on stocks with Bullish or Very Bullish ranks, but income investors should be willing to be flexible here, since they’re often willing to move lower on the reward-risk scale than are most other equity investors. But even for income seekers, we do want bullish ratings for some categories within the model
- Category ranks for the “Earnings Growth” and “Expert Opinions” must be Bullish: These tests are designed to steer us toward companies doing well earnings-wise well (and less likely to cut dividends) and tap into judgments of important stock market constituencies (that’s important — historic numbers alone aren’t enough in a world where past performance does not assure future outcomes).
- The factor rank for Return on Equity (ROE) must be bullish: This is the penultimate measure of corporate quality, an important thing if we care about dividend security. (We need not always emphasize it when we’re willing to take on more risk it’s ok to move down the quality scale, but this is a good time to be thinking about it).
- Yield must be above 2%
A surprisingly good number of stocks, 92 of them, passed the screen. To narrow further, I added some technical criteria (stocks should be technically “oversold” and above a rising long-term trend line). Steps like these can be important. It’s always easier to fly with a tailwind than against a headwind, whether literally (airplanes) or metaphorically (the stock market).
Based on a final review of the Chaikin Analytics price charts using the bottom-up process we recommend, I chose three interesting dividend-stock ideas.
Archer Daniels Midland (ADM) Yielding 3.27%
Ever since the covid-19 burst on the scene, the word “essential” soared in stature and use. ADM is as essential as essential can be; it’s at the epicenter of the global food chain. It buys corn and soybean crops, processes them in various ways, and sells for use as food (for humans — e.g., sweeteners, oils), feed (for farm animals), or energy (ethanol — well, not every large-cap company is humming on all fronts at all times, as this business is less sexy than it once was). ADM is not the sort of growth company with which the stock market has been obsessed lately, but it is solid, has slightly above-industry returns on equity and assets, a payout ratio in the high 40s, which is in line with sector norms, and as to growth potential, its not completely left off the train — its smaller nutritional segment is selling product for use in plant-based proteins. In terms of current operations, it always has its plusses (such as strong demand from china) and minuses (weakened demand for sweeteners from food-service customers, many of who have been hampered by covid concerns). It’s actually a bona fide “value stock” which has been seen lately on Wall street as a stigma, but the dividend looks secure and as of this writing, the stock is subject to a Chaikin “Oversold Buy” signal.
M.D.C. Holdings (MDC) Yielding 2.94%
This is a homebuilder, which is something you don’t usually find in the income-stocks arena. Relative to income stocks in general, its payout ratio is good (in the neighborhood of 30%). So why does MDC like to be more generous with dividends than are its industry peers? Management philosophy is obviously one reason. But another is that MDC keeps inventories lean (i.e. few “spec” homes — homes built without known buyers). Spec homes tends to tie up capital, and increase risk. A spec-home-heavy builder can profit more quickly and perhaps more vigorously in boom times, but if by now one doesn’t understand that homebuilding has bug busts as well, oh well . . . . By keeping its operational activities close to visible buyers, MDC is well able to customize homes (a margin-enhancing thing) and adapt to market trends. Today, extreme luxury plays well on reality TV and in social media but in the world at large, affordability is huge, and MDC definitely plays big this arena, as well as the move-down market. Economic woes and the ability to afford anything are concerns for the moment. But millennials are at first-time home-buying age and as the population ages, downsizing is a thing. Mortgage rates remain low, which is a good for this business.
Stewart Information (STC) Yielding 2.95%)
So how much time do you spend thinking about STC or its business? I’m guessing zero, even though you and everyone you know probably used it once or in most cases more often. This insurer focuses on real estate transactions; mainly the boring parts — title search and title insurance. Unless you are an attorney who does closings or actually remembers Property I, a search is something a buyer MUST do in order to avoid buying a property the seller doesn’t really own and later being evicted when the real owner shows up and says “What the #$@ are you doing in my house!” (Yes, this really used to happen and thats why we fuss so much about land records; The Mystery of Capital is a great book that discusses the consequences of not being up to snuff here.) And title insurance (STC’s main revenue generator) is what you need if the search got messed up and gave you the wrong answer. So this business goes hand-in-hand with real estate, but its dependent not on asset pricing but transactions, which happen when property values are rising and also when they are falling. Searches are also done for mortgage refinancings. The approximately-30% payout ratio is fine. Return on Equity beats the industry by a country mile. As can be seen in the above price chart, STC doesn’t just carry a Very Bullish overall Power Gauge rating, but all four rating categories score at the top of the scale.
Holding disclosure … No positions
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