As Congress heads ever closer to the fiscal cliff, investors — and in particular, retirees — are keeping watch and scrambling to protect themselves.
For those who feel we’ll certainly fall off the cliff and suddenly become taxpayers of up to 39.5% of our dividend income in January, the “fight or flight” reflex will tilt toward the latter. And hopping out of a long-term dividend portfolio will be the likely action.
Investors who believe Congress will somehow avert going over the cliff through negotiation and compromise are probably — and rightly — resigned to be paying higher rates on their dividend income.
I have cautioned — indeed, almost pleaded — for retirees and investors not to panic and undo what might’ve been years, or decades, of building solid and diversified dividend portfolios simply out of fear. Ben Rooney at CNNMoney last week wrote an excellent article that backs up my position, saying “the prospect of higher taxes has not diminished the appeal of dividend paying stocks for many investors.”
Rooney finds agreement from several money managers, including Allianz Global Investors’ managing director and portfolio manager Ben Fischer, who told him: “I really don’t see any change in the argument that you have to come back eventually to high quality dividend-paying stocks that have the ability to raise their dividends over time.”
I agree completely with Fischer’s assertion. Sure, I understand that taxing dividends at anything above the current 15% level is going to hurt, and my fingers are crossed that the new rate will be between 20% and 25% (wishful thinking?). But at the end of the day, income is still income, and dividend stocks from established and profitable companies should remain a mainstay of any portfolio, particularly for investors close to retirement.
Investors should still be looking for (or keeping) companies that fit this bill. A great place to start is companies with dividend yields in what Rooney calls the “sweet spot” between 3% to 5%.
The 3% floor is just about enough (at least at this point) to beat inflation, and with yields for 10-year Treasury bonds around 1.65%, a dividend yield at 3% is a nice premium.
On the other end, stocks paying out at a 5% yield are typically running up against their ability to keep raising dividends in any meaningful way. Stocks paying out enough to warrant yields like Pitney Bowes (NYSE:PBI) — now around 13% — are traps, and best avoided.
To speed your search, here are three companies that land in that dividend-paying sweet spot — and for an even safer measure, trade at price-earnings ratios at or below 15x, a fairly conservative historical level.
1) Abbott Labs
Abbott (NYSE:ABT) is a healthcare giant engaged in the discovery, development, manufacture and sale of products around the world. ABT comes in at a 3.2% dividend yield and a P/E right at 15x, all built on a base of operations that has paid out dividends since 1926. Abbott has a 40-year record of boosting its payout, including a healthy 8.8% annually over the past 12 years.
Abbott will split into two companies on Jan. 1, with Abbott Laboratories continuing its medical device business and the new entity — AbbVie — taking over pharmaceutical operations. Abbott’s business will retain a diverse portfolio of healthcare products, including nutritional supplements and foods, vascular devices, diagnostic and screening measures, and a generic-drug pharmaceutical operation.
InvestorPlace feature writer Dan Burrows recommends the stock, particularly because Abbott’s hepatitis C drug under development is showing great promise. Plus, the company is making strong inroads into emerging markets, which now account for nearly 25% of revenues.
One of the steadiest players in the oil and gas industry, Chevron (NYSE:CVX) is also one of the titans of the dividend-paying world, having started payouts in 1912. With a dividend yield right at 3.5% and a P/E of under 10x, Chevron is in a true sweet spot for dividend investors, with room to increase both dividends and capital appreciation.
While profitability suffered — along with other energy players like Exxon Mobil (NYSE:XOM) — as crude oil prices fell during the year, Chevron’s ability to generate cash and keep costs lower than its competitors led InvestorPlace‘s Tom Taulli to recommend the stock as a buy. I totally agree.
I’m sure to take some hits on this one, but Microsoft (NASDAQ:MSFT) is still worth a long look. While not the prom king anymore — an honor that now goes to Apple (NASDAQ:AAPL) — you can’t deny that it’s a mammoth company with oodles of cash, a solid 10-year history of paying out and hiking dividends, with a yield of around 3.4% and a P/E of under 15x.
I know: It’s in a business that many feel can’t last forever, but recent, aggressive moves to storm the mobile world with the Surface tablet and Windows 8 could be game-changers. And all those old PCs that will need to be replaced soon mean more money in Microsoft’s dividend bank.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he is long MSFT, XOM, and AAPL.