With more than a third of the global sovereign bonds market offering negative yields, it’s no surprise that investors have flocked to any source for cash yield.
The global hunt for yield has pushed prices up and rates down for everything from bonds to dividend stocks. You see it in the yield on the 10-year Treasury, which has fallen 1.26% over the last three years despite the fact that the Fed is aggressively trying to prepare investors for an increase in the Fed Funds Rate. You also see it in valuations for traditional dividend-paying sectors.
Traditional dividend picks in consumer staples and utilities are trading well above historic valuation multiples, creating a bubble that is destroying conventional views on safety sectors. The consumer staples sector is trading for almost 21-times expected earnings over the next year, a premium of 25% over its 10-year average, while utilities are trading 22% over their average at 17.8-times forward earnings.
Those safety sectors offered no shelter in Friday’s 2.45% selloff in the S&P 500. Utilities fell more than any other sector with a 3.75% plunge on rate fears, and consumer staples underperformed the market with a 2.71% loss on the day.
In fact, the loss on the Utilities SPDR (XLU) more than wiped out the annual 3.3% yield on the fund. The fund is still up 12% this year, but might have a tough time posting further gains against the potential for higher rates.
This investor herding into traditional yield plays is even more surprising when you consider the value available in other sectors.
Looking Outside Traditional Dividend Sectors For Cheaper Yield
Investors can still find value and yield by looking outside some of the traditional dividend sectors. The benefit to looking off the beaten path for yields is more than just cheaper valuations. Looking across multiple sectors and industries carries the added bonus of diversification in returns.
I found five names that are best-of-breed companies within their industries, and have the fundamentals to protect high dividend yields. Each company has a competitive advantage that will protect cash flow even if the rest of the market stumbles.
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Dividends at the five companies below are covered by an average of 187% by free cash flow and all five have aggressively repurchased shares. In the event of further market weakness or an economic recession, these five will be able to reduce repurchases to protect cash flow and even grow their dividend.
Quality Dividend Names On The Cheap: HollyFrontier Corp (HFC)
HollyFrontier Corp (HFC) is the largest independent refiner in the mid-continent region, with some facilities in the Rockies and Southwest as well. The company benefits from discount crude prices in its regions, relative to Gulf Coast prices, especially due to its proximity to Canadian oil sands producers. The improving Brent-WTI spread since July should lead to better profitability and cash flow.
Free cash flow covered the dividend by 123% last year, even as other oil companies watched cash flow evaporate due to lower crude prices. The company also owns a 39% stake in Holly Energy Partners, a pipeline and terminals MLP, which provides cash flow on volume deliveries rather than on strength in oil prices. While earnings have come down recently, the company is still generating over $700 million in operational cash flow. Combined with the dividend, the company returned $990 million to shareholders last year, over 22% of its market cap.
Earnings are expected to bottom 29% lower to $1.63 per share over the next year, which still puts the shares relatively cheap at 15-times expected earnings. The continued advantage on the Brent-WTI spread will drive earnings and stabilization in the industry could improve sentiment for a target of $28.85 per share over the next year.
Quality Dividend Names On The Cheap: Invesco Ltd.(IVZ)
Invesco Ltd. (IVZ) is a mid-market asset manager with $780 billion in assets under management. Despite the sale of its Atlantic Trust business, the company’s assets under management (AUM) have grown 2.3% annually over the last five years. AUM growth is important for asset managers because it’s their main source of fee-related revenue.
Shares took a hit on the Brexit vote, with 23% of managed assets tied to the European market, but are rebounding as the shock of the vote lifts. Free cash flow covered the dividend by 204% last year and nearly $550 million was returned through the buyback, boosting the total yield by 4.3% on top of the 3.5% dividend.
Earnings are expected almost 10% higher to $2.46 per share over the next year. Nearly three-quarters (73%) of the firm’s actively managed AUM has outperformed peers on a five-year basis and should keep inflows growing.
Continued AUM growth could push earnings above expectations and the shares should reach $35 each over the next year on a consistent 14-times multiple.
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Quality Dividend Names On The Cheap: Pfizer Inc. (PFE)
Pfizer Inc. (PFE) is one the world’s largest pharmaceutical firms, with nearly $50 billion in annual sales and the economies of scale to support a huge salesforce. The company has worked through the bulk of its near-term patent expirations, with only Viagra coming off protection in 2017.
Pfizer is a cash machine, generating $13 billion in free cash and covering the dividend by 188% last year. The company has scaled back its R&D spending which could drive cash flow even higher over the next couple of years. Pfizer returned another $6.2 billion through its share buyback program in 2015, for a 2.9% yield beyond the 3.5% dividend yield.
Earnings are expected 2.5% higher to $2.50 per share over the next year, but the company has a strong history for beating expectations, missing only once in the last 16 quarters. Shares fell from the 52-week high in August, representing a buying opportunity on the $38.25 per share target at 15-times forward earnings of $2.55 per share.
Quality Dividend Names On The Cheap: Emerson Electric Co. (EMR)
Emerson Electric Co. (EMR) could almost double its market share to 13% in the final control segment of the industrial automation market with its acquisition of Pentair plc. Ordinary Shares’s (PNR) valves and control business. The $3.15 billion acquisition is expected to be paid for completely through estimated after-tax proceeds of $4.3 billion in divestitures of non-core products.
Free cash flow covered the dividend by 145% last year even as energy-related business stumbled. The company returned $2.5 billion to shareholders through the buyback last year for a 7.4% yield on top of the 3.6% dividend yield.
Shares trade for 18-times trailing earnings with profits expected 1.5% higher to $2.95 per share over the next year. Shares could climb 7.7% higher to my target of $57 on a slight earnings beat and the five-year average multiple of 19-times earnings for a total return of 11% over the next year.
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Quality Dividend Names On The Cheap: Carnival Corp (CCL)
Carnival Corp (CCL) is the largest company in the cruise industry and enjoys strong demographic tailwinds. Only half of the industry’s addressable market has ever taken a cruise, and the retiring baby boomers represent a huge opportunity. Free cash flow covered the dividend by 276% last year and operational cash flow has surged 60% over the last two years.
The company has boosted its buyback program, returning $1.9 billion to investors over the last year for a 7.2% yield on top of the 2.9% dividend yield. Earnings are expected to jump 10% to $3.45 per share over the next year and the shares could regain this year’s high around $52.75 on stronger sentiment and earnings.
Risks To Consider: While fundamentals are strong at all five companies, high dividend payouts may limit share price appreciation in a low economic growth environment.
Action To Take: Find value and yield outside the traditional dividend-paying sectors in these five names for potential upside appreciation and market-beating payouts.
Editor’s Note: Most people think you have to sacrifice growth for income. But we’re holding 23 monthly dividend payers… and have seen our portfolio grow 50%. Get all the details here, including names and ticker symbols.
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