by Hilary Kramer | April 6, 2012 1:13 pm
With the Federal Reserve having kept interest rates at historical lows near 0% for more than three years now, many stocks kick out dividend yields far in excess of what you get in savings accounts, CDs and money market funds.
One thing we can be sure about is the direction interest rates will go next: It has to be up.
It’s less certain how fast they will move and how long the move will last, but we’ve seen rates start to move a little bit recently. The yield on 10-year U.S. Treasuries rose from 1.87% at the end of last year to a high of 2.4% last month; it currently is around 2.2%.
Does the prospect of higher interest rates make dividend-paying stocks less attractive? No. We are moving toward the point where interest rates could become more competitive, but there are enough concerns around the world to keep the safety of Treasuries appealing to investors, which should keep yields from rising in a hurry. As a result, many good stocks still have higher yields than 10-year Treasury notes, and I expect that to hold true for a while.
That might not be the case further out in, say, two years, and that’s why it’s important to look for more than yield in dividend-paying stocks. You also want to look for companies that consistently increase their dividends. A company yielding 2% today that increases its dividend each year will often be a better buy over the long term than a stock with a 3% yield but a flat dividend.
Another reason: Companies only raise dividends if they are comfortable with their outlooks, thereby increasing the probability the stock will increase in value while you collect the dividends.
Here are four U.S. blue chips worth a look right because they have solid yields, strong histories of raising dividends and promising outlooks:
Global food giant General Mills (NYSE:GIS) yields an attractive 3.1%, and it’s a yield you can count on. General Mills has paid a dividend for 113 years, never lowering it. Over the last five years, the dividend has jumped from 72 cents to $1.12, an average increase of 10.5% a year. The company’s fiscal year ends in June, and for the last eight years (2004-11), GIS has raised the dividend at that time.
The stock itself is in good position to move higher, too, given that General Mills finally is executing its international strategy. Third-quarter net international sales grew 51% to $1.04 billion. Commodity prices were an overhang in the last earnings report, but they should moderate, and the company was able to pass the price increases to consumers, a sign of strength. General Mills also is adept at finding growth organically — like creating new consumer segments such as healthy snacks.
Another food company is Campbell Soup (NYSE:CPB). Earnings have struggled a bit in recent years, but cash on the balance sheet is $322 million, which bodes well for the current 3.4% dividend yield. The company also has raised the dividend steadily, growing an average of 7.7% annually over the last five years.
As with every packaged goods company, commodity prices have impacted Campbell’s, too. The most recent quarterly results were disappointing. A 1% sales decrease reflected higher commodity prices, weakness in Canada, Europe and Australia, as well as the cost of expanding into China. Going forward, commodity prices should moderate, and in the meantime, CPB remains a very profitable business. Margins are wider than other food sectors, and V8 juice product extensions have helped to grow the beverage business. Campbell’s also has identified areas of weakness that need improving — namely, the company is investing in building brands through consumer promotions, advertising and competitive pricing.
There might not be as much upside potential in the stock as with GIS, but CPB remains a solid business and a dividend stalwart.
Occidental Petroleum (NYSE:OXY) has raised its payout sharply in recent years. In fact, the dividend has more than doubled from 88 cents (annualized) in 2007 to $2.16 today. Dividend growth over the last five years has averaged an impressive 19.7% annually.
OXY is a quality company that is a pure play on oil, so it should do well with oil prices consistently at or above $100 per barrel. The 2.2% yield is lower than GIS and CPB, but it’s still strong and appears likely to increase with future dividend hikes.
Illinois Tool Works (NYSE:ITW) has paid a dividend for nearly 25 years, starting at 4 cents (annualized) in 1988 and rising to $1.44 for a current yield of 2.5%. Dividend growth over the last five years has averaged 11.4% annually. If you bought the stock at the end of the first quarter in 2007, you would be up 27% including dividends versus 11% in the underlying stock.
You might not have heard of ITW’s 800 brands, but they are leaders in their markets. The company manufactures products for industries around the world, including food and beverage, construction, electronics and automotive. Sales of both cars and trucks are expected to be up this year. With autos on the road almost 11 years old on average, pent-up demand should drive consumers to buy new ones.
ITW also should become even more profitable by improving operating margins of newly acquired businesses as well as its base businesses. ITW has proven successful at this in the past. In fact, over the past 25 years, management’s strategies have yielded an average 13% compounded annual rate of return for shareholders.
Utilities always are popular dividend stocks. At the moment, however, I would put them in the “no growth” category that should be avoided, as there are regulatory, political and economic risks that could pressure the underlying stocks. You would think an improving economy would point to improved earnings for the utilities, but it doesn’t always flow through that directly. Another concern: The capital improvements required are immense, as our utilities are in dire need of upgrades and even overhauls in some cases.
I also would be wary of REITS in general. There are many different types, of course, and they don’t all have the same growth profile, but most deal in commercial real estate (like shopping malls and office buildings) and get their income from rents. REITS are reputable investments, but the problem is that valuations are very rich given that investors have piled into them since the market bottomed in 2009.
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