by Louis Navellier | November 27, 2013 8:00 am
In the bond world, credit ratings influence any bond’s yield. If bonds are rated AA or A, for instance, they are expected to yield within a certain range. Also, bond yields tend to fall before an upgrade — which is generally driven by the improving finances of a company, or its better ability to service its current debt.
Similarly, if a company’s finances start to deteriorate, the yield on its bonds tends to fall toward the lower credit rating range, even before any downgrades. All in all, bonds in the same industry or category more or less tend to have similar yields for a similar credit rating, so bond yields can be relatively predictable.
Dividend yields are more erratic, since they are offered at the discretion of the company’s board, while coupon interest is an obligation. In other words, if the company has outstanding, plain-vanilla corporate bonds, the company must pay the stated coupon interest. If the company has outstanding public shares, however, management is not obligated to pay any dividends. Nevertheless, most companies have gotten into the habit of paying regular and steady dividends, and a dividend cut is seen as a sign of weakness.
This is not at all how things work in many other parts of the world. In many cases, managements outside the U.S. tend to pay dividends a couple of times a year, and they are not the same steady and typically-growing amounts. This strategy is also becoming popular with the top U.S. dividend payers, as it gives them the flexibility to reward their shareholders and run their businesses in a better way. If management feels they have better uses for cash, they may forego the dividend or pay a smaller amount. A company with a more profitable business may pay a smaller dividend than one with a less profitable business.
A good example is Apple (AAPL)*, which overnight became the second highest payer of dividends in the S&P 500 (as measured by the total amount of dividends paid). Apple sits on $146.8 billion in cash, but it needs a good part of that cash hoard to develop iPhones with curved screens (and who knows what other gadgets coming down the line), or it may want to build a new headquarters, or who knows what else. Apple is an example of a company that can afford to pay a higher dividend, but can probably find better uses for its money (for instance, using its cash to guarantee deliveries of key components in tight supply).
The top dividend payer in the S&P 500 (by total dollar amount) is Exxon Mobil (XOM)*, the company that used to have the biggest cash pile before Apple came up with the iPhone. In this case, there is a peculiarity, where Exxon’s credit rating is AAA, while Apple is rated AA+ , even though Apple has more cash than all the AAA-rated U.S. companies combined.
The issue for the rating agencies is that high-end mobile computing is a fiercely competitive business. The fact that Apple is so profitable today does not mean that it will be profitable in five years. Apple still has to service its debt taken on for buybacks and the servicing of its dividends. True, Apple did not need to borrow this money, but it chose to, with negative real interest rates on short maturity AA+ bonds, which is the closest thing to “free money.”
So, if the most profitable companies in the S&P 500 with the highest credit ratings do not pay the highest dividends as a percentage of the share price, who does? Typically, the highest dividends in the S&P 500 are in the slow-growing utility and telecom sectors – well-established businesses with stable cash flows.
A perusal of the top three dividends payers (as of last quarter) yields a surprising result: No utilities.
The #1 dividend payer as a percentage of the share price (over the trailing 12-months, or TTM, to Sept. 30, 2013) is an apparel company called L Brands (LTD)*, which in the past year yielded 7.1%. This is the old Limited Brands, which changed its name and decided to issue a series of special dividends to turbocharge its share price, as it had the earnings power to do it. It issued special dividends of $1 and $3 in March and December of 2010, in addition to its regular dividends, then added special dividends of $1.00 and $2.00 in June and December of 2011, and special dividends of $1.25 and $3 .00 in August and December of 2012.
It has not issued any special dividends in 2013, but it sure made up for that with the $4.25 total in 2012. The special dividends skew the payout ratio, which stands at an absurd 187%, but there is $872 million (and growing) in levered free cash flow for more dividends, so I would not think that L Brands is done on the special dividend front. It seems they stretched themselves in late 2012 to get the expiring lower tax treatment for dividends and may again surprise investors in 2014.
LyondellBasell Industries (LYB)* — the second- highest yielding company in the S&P 500 on a TTM basis — is a different story. LYB also issued special dividends in 2011 and 2012 of $4.75 and $3.15, respectively, with no special (but higher regular) dividends in 2013.
Still, this is a major chemical company whose U.S. operations filed for bankruptcy in 2009. I’m not calling for a recession, but chemical companies are notoriously cyclical, and they sometimes go bankrupt if they carry too much leverage in downturns. This is a perfect business for special dividends, when there is money to give them, but it is also a business that should not carry high debt levels, given the cyclicality of the chemical business.
The third highest S&P 500 yielder is also a little surprising, as it is an oil-service company, Diamond Offshore Drilling (DO). Typically, oil-service companies have volatile dividends, but DO is in the deep-water drilling business, which has much longer-term contracts for its projects. It can survive oil price storms with much less sensitivity to its P&L statement than a land driller can. Since 2006, DO has delivered $35.88 in regular and special dividends, which is impressive given its $61 share price.
As you can see, dividends are much more arbitrary than coupon interest, but both dividends and bond coupons have a place in an income investor’s portfolio, as they tend to complement each other.
*Navellier may hold this security in one or more investment strategies offered to its clients.
Written by Ivan Martchev
Source URL: http://investorplace.com/2013/11/dividend-stocks-xom-aapl-lyb-ltd/
Short URL: http://invstplc.com/1nwrVDz
Copyright ©2014 InvestorPlace Media, LLC. All rights reserved. 700 Indian Springs Drive, Lancaster, PA 17601.