Shop for Dividends in This Aging Bull Market

By BRETT ARENDS
NOVEMBER 22, 2009


Wall Street has rallied a long way since the dark days last winter. But there are still plenty of blue chips offering big dividend yields.

Screen the market for yields over 3% that are well-backed by earnings and a surprising number of big household names come up -- Kraft Foods, Clorox, Sara Lee, Sysco, Johnson & Johnson, Merck, BP, NStar, Verizon Communications and AT&T.

A lot of these steady Eddies have been left behind by this year's mad stampede for higher-risk, higher-excitement investments -- from China to the Cheesecake Factory.

It's a good time to remember that high-excitement stocks often end up providing investors with high drama and high blood pressure instead.


More boring "value" stocks -- established companies in more stable or "defensive" industries -- have usually proven a better long-term investment. (Defensive industries include food and beverages, health care, personal care, household goods and even telecoms.) And even if they make fewer profits for you on the way up, they lose a lot less on the way back down.

Tempting for Income Investors

Right now top dividend stocks have extra appeal. That's because they offer a tempting alternative to cash or bonds for those who need income.

Many savers are trapped between short-term savings like bank accounts or CDs, paying virtually no interest at all, and longer-term bonds, which pay a little bit more -- and leave you at the mercy of inflation.

"Why own bonds when you can own 'defensives'?" asks Bijal Shah, strategist at investment company Icap.

Such stocks "are cheap in absolute terms," Mr. Shah says. "The dividend yield of U.S. defensives now equals the yield on 10-year Treasurys.... And the dividends and earnings of defensives grow very steadily, unlike the earnings stream for the overall equity market."

Where should the dividend hunter look? And what should you avoid?

Watch out for a dividend that's too high, especially anything in or near the double digits. That's usually a red flag. It means the stock market expects the payout to be cut, or even -- in the case of some smaller companies, such as mining stocks -- that management is slowly winding down the business.

It's also probably best to avoid companies in the most volatile industries, like financials or industrials. Many years ago, Guy Hands, one of London's top private-equity managers, explained to me that he tended to steer clear of manufacturing companies because the cash flow was too volatile. It's still true.

Investors in General Motors thought they had locked in a great double-digit dividend yield -- before the payout, and the stock, went to zero. So, too, did investors in Washington Mutual. There are easier ways to make a living.

Check Out the Finances

Judy Saryan, a fund manager at Eaton Vance in Boston who specializes in dividend stocks, says the first thing she checks with a stock is the company's balance sheet: Does it have big, or unknown, potential liabilities that could blow up the company's finances? Paying attention to balance sheets steered her fund around many icebergs over the past few years.

The second thing to check is the cash-flow statement. Is the company earning enough to keep paying dividends? How much of a cushion is there if business turns down?

Her favorite sign: A company that's actually raising payouts. "If a company grows its dividend," she says, "that's the best signal the management and the board can give that they have confidence in the future."

What are her picks right now? Ms. Saryan likes many big drug companies, seeing strong cash flow and solid balance sheets at the likes of Merck, Abbott Laboratories, and overseas firms Sanofi-Aventis, Novartis and AstraZeneca.

Also on her list: Major consumer-product firms like Procter & Gamble, PepsiCo, Colgate-Palmolive and McDonald's.

Technology stocks have boomed this year, but a few big companies still offer reasonable yields, including Analog Devices and even Intel.

But some of the fattest yields are to be found in telecoms. "Verizon is very attractive," Ms. Saryan says. "It has the best quality network" and a 6%-plus yield. And there's possible upside if the network can offer customers an Apple iPhone next year, as some rumors suggest could happen.

She also likes overseas mobile giant Vodafone, and Spain's Telefonica, whose U.S.-listed shares have a 4.7% yield. Telefonica has emerging-markets growth because Latin America now accounts for about half of its sales.

Pay Attention to Funds, Too

Picking individual stocks can be risky as well as time-consuming. Those looking for an easier life can look at "equity income" mutual funds. These invest in dividend stocks, and they will do the work and spread your bets for you.

One option: a low-cost exchange traded fund like the iShares Dow Jones Select Dividend Index Fund, which currently has a 3.9% yield. Keeping your fees low is a sound principle in investing.

Another possibility: shares in a closed-end fund that invests in dividend payers. Closed-end funds are mutual funds that trade on the market like stocks. You can sometimes, like now, buy them at a discount to their net assets.

Ms. Saryan's Eaton Vance Tax-Advantaged Dividend Income Fund is one. It has a payout rate of nearly 9%. It's trading for about 10% below the value of its investments, and has further goosed returns by borrowing money cheaply at short-term interest rates to buy more shares. Be aware that borrowing can increase volatility.


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