TAG | Yield
15
The One Place to Invest for Growth, Income… and Safety
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The One Place to Invest for Growth, Income… and Safety
by Alexander Green, Investment U Chief Investment Strategist
Monday, November 14, 2011: Issue #1642
Eight weeks ago, I wrote an Investment U column pounding the table for dividend stocks. Since then, they’ve ratcheted higher, but I still see plenty of upside ahead.
Someone who shares my enthusiasm for high-yield stocks right now is my friend and former colleague Rick Pfeifer, Senior Portfolio Manager at Fund Advisors of America, a Florida-based money management firm.
On a recent trip to the sunshine state, I stopped into his office to hear why he, too, feels this is one of the best places to put your money to work today.
Q: Rick, there’s an awful lot of fear and anxiety about the economy and the stock market right now. Investors are confused and uncertain about what to do with their money. What is your take on things?
A: In a market as volatile as this, you have to spread your bets. But my take is this: If you’re looking for growth, buy dividend-paying stocks.
If you’re looking for income, buy dividend-paying stocks. If you’re looking for safety, buy dividend-paying stocks.
Q: Why?
A: The first question every investor has to ask himself is, “How should I divide my money among stocks, bonds and cash?”
The average money market fund currently pays two one-hundredths of one percent. At that rate, you will double your money in just 3,600 years.
Q: Not terribly attractive.
A: Definitely not.
And Treasury yields won’t make you jump up and click your heels, either. The 10-year guy is yielding two percent, which translates – at best – to a zero-percent yield after inflation.
Q: Tough to meet your investment goals that way.
A: Right.
In my view, dividend stocks are a good place to be right now for several reasons. Let’s talk about safety first. When the Dow traded at these levels 11 ½ years ago, it sold for 47 times earnings. Today it trades at less than 14 times earnings. Stocks are cheap right now on the basis of sales and earnings.
But even during market declines, dividend-paying stocks hold up better than non-dividend-paying stocks and sometimes fight the broad trend and rise in value. The reason is obvious. These tend to be mature, profitable companies with stable outlooks, plenty of cash and long-term staying power.
Q: U.S. companies are sitting on a record amount of cash now, too, right?
A: Correct.
U.S. companies currently hold more than $2 trillion in cash, a record. Thanks to this economy and the current Administration (don’t get me started), companies aren’t hiring and they’re not boosting spending. So a lot of this cash is rightfully going back to shareholders.
The Dow currently yields more than bonds. And dividend growth among U.S. companies has averaged 10 percent per year over the last two years, more than double the long-term dividend growth rate.
Q: Okay. Dividend stocks are less risky than non-dividend payers and currently pay more than cash or bonds. But how do you think this group will perform in the years ahead?
A: We can only use long-term historical performance as a guide, but the numbers are pretty darn encouraging. Over the last 50 years, for instance, the highest 20 percent yielding stocks in the S&P 500 returned 14.2 percent annually.
That’s good enough to double your money every five years – or quadruple it in 10. And if you were even more selective, say investing only in the 10 highest yielding stocks of the 100 largest companies in the S&P 500, your annual return would have been even better, 15.7 percent.
Q: We should add the standard caveat here about past performance and point out that there are risks with dividend stocks, too, right?
A: Indeed. You have to be selective. An investor would be foolish to plunk for a stock just because the dividend is large. The market is full of “dividend traps,” troubled companies that pay hefty dividends to keep investors from bailing out.
Q: How does an investor avoid those?
A: Mainly, by doing his or her homework. You need to look at prospective sales and earnings growth. You have to examine the balance sheet and make sure that the company isn’t too highly leveraged.
You have to note cash balances. And, perhaps most importantly, you need to analyze whether the payout ratio is sustainable.
Q: So can you give us a few examples of high-yielders that have you been buying in your managed accounts lately?
A: I’ve been nibbling at Windstream Corp. (Nasdaq: WIN), a well-run communications and networking company with an 8.3-percent current yield. I like oil and gas producer Enerplus (NYSE: ERF), with its high operating margins and 7.7-percent dividend.
And – this one is a bit different – I’ve been picking up a 10.3-percent yield with the Gabelli Global Gold Trust (AMEX: GGN). There are plenty of other attractive high-yield situations out there, too. They should be owned, of course, as part of a more broadly diversified portfolio.
Q: I agree, Rick. Thanks for your time. Let’s chat about this sector again in a few weeks.
Good investing,
Alexander Green
[Editor's Note: Fund Advisors offers Investment U subscribers a complimentary portfolio review. For more information, feel free to call Rick - or his partner Greg Galloway - at 800.438.3040 or 407.667.4729.]
28
Here's a Hot "TIP" You Shouldn't Buy
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Here’s a Hot “TIP” You Shouldn’t Buy
by Alexander Green, Investment U’s Chief Investment Strategist
Thursday, October 28, 2010: Issue #1376
Six months ago, I made a strong case for buying inflation-adjusted Treasuries, better known as TIPS.
I suggested that Washington’s massive fiscal stimulus, plus record-low interest rates, might ultimately prove inflationary.
So far, they haven’t. But investors clearly feel that inflation – the thief that robs us all – is just around the corner.
Look at the traditional inflation harbinger – gold. The metal has hit one new high after another this year.
TIPS (Treasury Inflation-Protected Securities) have soared, too. In fact, they’ve rallied so far that for the first time ever, five-year TIPS were sold at auction earlier this week with a yield of minus 0.5%.
That’s right… they guarantee a negative yield. Yet investors are gobbling them up anyway.
What’s going on here? Let’s start at the beginning…
The Inside Track on TIPS
Here are some Treasury Inflation-Protected Securities (TIPS) characteristics…
- They pay interest every six months, just like a regular Treasury bond.
- Unlike traditional bonds, your principal increases each year by the amount of inflation, as measured by the consumer price index (CPI). The semi-annual interest payments also increase by the amount of inflation.
- The interest you receive is exempt from state and local income taxes (but not federal).
- TIPS are less volatile than traditional bonds.
- TIPS are excellent diversifiers.
But can TIPS possibly be worth holding, even when they sport a negative yield?
Perhaps for long-term investors (as I’ll explain in a moment). But not for short-term traders. Here’s why…
Think Twice Before Buying TIPS for the Short-Term
Current yields of less than zero on TIPS are due to rock-bottom Treasury rates and fears of higher inflation just over the horizon.
It’s simple math. Five-year Treasuries are yielding a paltry 1.2%. Given the weak dollar and Washington’s addiction to spending, traders and investors are betting that inflation will run at 1.7% or more.
That makes five-year TIPS just as attractive as five-year bonds, since 1.7% minus the 0.5% negative yield equals 1.2%.
Inflation or Disinflation?
Of course, the financial markets are a bit schizophrenic right now. Inflation protectors like gold and TIPS have rallied. But so have inflation-sensitive investments like investment grade bonds. Investors can’t seem to decide whether we’re in for inflation or disinflation.
And of course, nobody knows for sure. But TIPS have rallied by 10% over the last year, with no uptick in inflation. If the folks betting on disinflation – or its more severe cousin, outright deflation – are right, these bonds could undergo a serious price adjustment, giving investors a haircut in the process.
TIPS investors aren’t just guaranteed negative yields right now. They may also experience a negative total return for several years in a row.
So why shouldn’t long-term investors sell them outright?
How to Tackle TIPS if You’re a Long-Term or Short-Term Investor
Some would be prudent to do just that. The only catch is this: What if the inflation hawks are right?
If they are, TIPS will give a higher future return than traditional fixed-income investments – and with the highest degree of safety. (They are, after all, obligations of the U.S. government.)
True, there are other inflation alternatives. But gold has already quintupled over the last decade. And that other famous inflation hedge – your home – is likely to remain mired in quicksand for years to come, thanks to the overhang of foreclosures and other unsold properties.
The bottom line is this:
- Long-term investors – those with a time horizon of five years or more – should hold onto their TIPS.
- But traders and other investors with a shorter time horizon should probably give them a miss.
History shows that once an asset class turns hot – whether it’s stocks, bonds, gold, real estate or TIPS – it rarely delivers the kind of returns it did when it was heating up.
This time could be different, of course. But that’s how investors always rationalize their investments at the top.
The oldest advice is still the best: Caveat emptor.
Alexander Green
1
U.S. Treasury Bonds: Why the Safest Investment is Now One of the Riskiest
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U.S. Treasury Bonds: Why the Safest Investment is Now One of the Riskiest
by Alexander Green, Chief Investment Strategist
Tuesday, June 1, 2010: Issue #1271
U.S. Treasury bonds are the safest investment in the world.
However, that doesn’t mean they can’t be dangerous. Far from it.
Yet a few days ago, The Wall Street Journal reported that, “Long-dated Treasury securities are now the most favored financial assets for global investors fleeing the eurozone’s debt crisis.”
Talk about jumping out of the frying pan and into the fire…
Don’t get me wrong. I’m not one of those end-of-the-worlders who expect the U.S. government to default on its sovereign obligations. That won’t happen.
It wouldn’t even be necessary. After all, history shows that governments always prefer to inflate their way out of a debt crisis by cranking up the printing presses instead. That way they can achieve a de facto debt reduction simply by devaluing the currency.
If you’ve seen the photographs of German citizens hauling wheelbarrows full of cash into the bank during the days of the Weimar Republic, you know what I’m talking about.
Of course, I don’t expect inflation like that. And neither should you.
But what kind of inflation does an investor expect who loans his money to the government for 30 years at a rate of just 4.1%?
Why U.S. Treasury Bonds Could Bulldoze Your Portfolio
That 4.1% figure is the current yield on the long end – and it’s a bet that has a little upside potential and a whole world of downside risk. Why?
Imagine a seesaw with interest rates and inflation on one end and bond prices on the other. If inflation goes down, bond prices go up. And vice-versa.
But how far down can rates go on the long end? Unless we have the sort of deflationary environment that Japan suffered in the 1990s, the appreciation potential here is minimal.
On the other hand, if inflation rears its ugly head, long bonds will get clobbered. And the worse inflation gets, the worse these bonds will do.
I realize that inflation is not an immediate threat. Technology and deregulation have brought costs down over the past decade. And even oil prices have moderated lately.
But if the bond market gets even a whiff of higher inflation, these bonds will drop like a stone. And I’m betting that investors who weren’t around during the early 1980s – and even many who were – don’t realize it.
They are so busy patting themselves on the back for eliminating default risk – and picking up a 4% yield versus next-to-nothing on the short end – that they are forgetting about interest rate risk: the risk that higher inflation will send long yields soaring and bond prices crashing.
Don’t Let the Government Trick You into Speculating
Seth Klarman, President of the Baupost Group, an investment firm in Boston that manages $22 billion, says the U.S. government is inadvertently provoking its citizens into taking very bad risks right now.
How?
“By holding short-term interest rates near zero, the government is basically tricking the population into going long on just about every security except cash, at the price of almost certainly not getting an adequate return for the risks they are running. People can’t stand earning 0% on their money, so the government is forcing everyone in the investing public to speculate.”
Of course, most people aren’t exactly in a speculating mood right now.
So what are they doing? They’re buying super safe long-term Treasuries and earning over 4%.
Except that’s not a safe investment – as many will eventually learn to their chagrin.
Good investing,
Alexander Green
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