It’s rare to find stocks with dividend yields that are in the neighborhood of their price-to-earnings (P/E) ratios. But the persistent concerns about global growth have created an unusually high number of these inexpensive yield opportunities in the energy and materials sectors.
Notably, many of these value plays aren’t royalty trusts or REITs, and they aren’t troubled stocks or obscure names with sub-$5 stock prices. Instead, they’re some of the largest and most recognizable names in the global markets:
Click to Enlarge Vanguard Natural Resources (NYSE:VNR)
Yield (12-month forward): 8.2%
P/E (2013 estimates): 12.9
Payout ratio: 79%
VNR has raised its distributions for eight years in a row, and it just announced a dividend increase on Monday, July 23.
China Petroleum & Chemical (NYSE:SNP)
Payout ratio: 25%
Payout ratio: 47%
Payout ratio: 34%
Royal Dutch Shell (NYSE:RDS.A)
Payout ratio: 34%
Click to Enlarge Vale (NYSE:VALE)
Payout ratio: 38%
Rio Tinto (NYSE:RIO)
Payout ratio: 39%
Freeport McMoRan (NYSE:FCX)
Payout ratio: 32%
As is usually the case, these high yields are accompanied by high risk. All of the stocks on this list are subject to the vagaries of commodity prices, which in turn depend on the outlook for China’s economic growth and the debt problems in Europe. So, make no mistake: buying any of these stocks is, in large part, a bet on the global growth outlook.
At this point, however, that actually might not be a bad thing. Expectations for growth are already very low, meaning there’s greater latitude for positive surprises. Then there’s QE3. If the Federal Reserve steps up with another stimulus program, depressed natural resources stocks are likely to be among the market’s top performers in the resulting rally.
These stocks are also well-positioned to deliver strong returns for long-term investors. Buying established companies at low valuations has been a winning strategy over time, especially when you get a high yield to provide a favorable starting point for total returns. An investor who can buy and hold stocks such as these is likely to find handsome returns five or more years down the road.
With that sort of time frame, it may be worth asking which approach is less risky: owning these stocks at single-digit P/Es or holding the countless defensive, consumer-staples companies at their current peak multiples.
There’s no doubt, any of these energy and materials stocks could be hit hard in the short term — if Europe blows up, P/Es and yields aren’t going to matter. The solution to this conundrum — short-term risk, long-term potential — is to scale in. Build positions slowly, adding on weakness and selling calls on strength to boost the income stream.
And if Europe finally does collapse at some point in the next two to three years, be ready to deploy cash aggressively to capitalize on the tumult.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.