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.]