Where to Hunt for Big Yields

01/22/2013 7:30 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

At this point, the answer is "everywhere." The real trick is to be thoughtful and selective when you're looking for these solid cash cows, says Roger Conrad of Personal Finance.

Gregg Early: We're here with Roger Conrad, editor of Personal Finance and Utility Forecaster. Roger, where should investors look for yield in 2013? Are there specific sectors? There's been so much demand for dividend-driven stocks that I'm not quite sure that there's anything left out there.

Roger Conrad: Well, I think that there are a couple of macro factors that we need to keep in mind. One is the fact that there is some austerity coming in the United States. We've seen some tax increases-not as much as people feared at one point, but nonetheless those are going into effect, particularly the Social Security tax.

Then we also have later on, probably some spending cuts that will be of about the same magnitude, I would expect. When you add that up, I think the estimate is about 1.9% of GDP, which is actually more austerity than some of the other countries, like Britain, had been doing.

We are seeing some good signs in the US economy with growth, particularly on the employment side, and of course China had a pretty good number. So there are some offsets, and it's possible that with all the cash that corporations have on the books right now that we'll see the economy pick up even with this austerity.

I think people need to really be concerned about individual companies. I guess I've always been more or less in that camp where you really look at how strong an individual company is and whether the dividend can hold against the worst that might happen. In this case, I think probably the worst case is slow growth or no growth, and maybe some tighter credit conditions as a result of that as people start to worry about creditworthiness of weaker companies.

There's really no sector that's immune from those types of pressures, but there are companies in different sectors that can pay dividends and have proven that they can pay them in really bad environments-2008 being a great proving ground.

What we've been doing is looking around in all of these different sectors-and of course, it's kind of a core philosophy that people who are investing in stocks should have them in a very large range of sectors-but looking through and finding companies that have minimal debt coming due the next couple of years. If they don't have debt coming due through the next couple of years, they don't really have that much refinancing risk.

Then, companies that have proven that their revenues are reliable in difficult times-again, 2008-2009 is a pretty good example. I think you can find these things. You can find good, high-yielding stocks in a range of areas...but again, you have to be very careful about what the underlying strengths and weaknesses of those companies are.

Gregg Early: So, it's kind of a secular view that you're taking on it, that there are quality companies in every sector, that the best thing to do at this point-the strategy-is really to find the quality companies that are going to be able to pay. That you don't go after the big dividends-the giant, double-digit dividend-because then you have the risk that it's not going to be able to pay if the economy continues to slog along.

Roger Conrad: Well yes, absolutely. There are some companies out there in sectors-well, let's take a company, Windstream (WIN), that's a rural telephone company. It yields a little bit over 10%.

They've got a really nice arrangement, I guess, in the tax deal that's going to dramatically increase their free cash flow this year. Then, as they build out their fiber network and fiber to the tower, those types of things, they're solidifying revenue and they're going to wind down their capital spending starting next year.

So a lot of things are coalescing to make their dividends a lot more secure than it looked last year. But it's still yielding over 10%, and that's an example of, I think, a company where you do have value even though you do have a pretty high yield. There again, to become aware of it you've got to dig in there a little bit.

There are other companies that are yielding very high levels as well. You're absolutely right. Those are companies you'll probably want to steer clear from. And again it's coming down to, I think, revenue security. Can you project a line of [revenue] if the economy remains kind of soft? Can you project if they're going to be able to earn enough money to cover the dividend?

If you look at the sector that Windstream's in-the rural telephone sector-it's littered with companies that have slashed dividends over the past year or so because they couldn't make it. You know, Windstream is, I think, cheap because of that sort of guilt by association.

But, again, if somebody's willing to look in there and see the difference between Windstream and say, Alaska Communications (ALSK) or Otelco (OTT)-which both of them eliminated their dividends actually in the last six months. Big differences, but maybe overlooked for somebody that's really looking more from 30,000 feet. Those are the kinds of opportunities I think are out there, as well as the kind of dangers that lurk.

Gregg Early: Right, and I think that's it, that you can get a 14% dividend somewhere but they might end up cutting it, whereas if somebody's going to tug along at a nice, juicy 10%-it just takes a little bit more footwork and you have to read up on it a little bit. It's not just about looking at the number; it's looking at the company underneath that number, especially in strategic sectors like that where they have a bad reputation because of some of the problems that some of those high yielders have had.

Roger Conrad: Yes, and I think you could even apply that same sort of logic to sectors that have been a little more popular like Master Limited Partnerships. Of course, it doesn't look like there will be some kind of grand bargain and tax overhaul that does anything to Master Limited Partnership tax advantages, so that's a big plus.

With tax rates going up, and particularly for higher-bracket investors, these things have become a little bit more popular. Of course, we've had some pretty massive success stories with companies able to consistently raise distributions for strings of-some of these-30 quarters or more of consecutive dividend increases.

They're just adding assets and adding...just being able to boost their distributions and yields because of that. It's a pretty well-known story and there's a lot of success there, but there is a lot of differentiation between individual companies.

If you look at say, something like Enterprise Products Partners (EPD), it's very reliable and in fact increasing its distribution. They've been accelerating their rate of increase. The problem has been getting it at a good price but that's actually now a pretty good value, yielding right around 5%.

If you look at another company that's a propane distributor, Ferrellgas Partners (FGP) -that one, right now, yields about close to 11%, but the reason is there are some serious questions about the propane distribution business regarding weather, regarding cost of fuel, and they have not actually been earning their dividend for several years, so they've been funding it off their balance sheet.

That doesn't necessarily mean that someday they may end their dividend, but it does mean that it's considerably more risk. So again, another pretty good example of why an income investor is probably going to do a little better being very, very selective about what they buy and again, sticking with companies that have more revenue security and lower debt.

Related Readings:

Who's Got the Top Stocks for 2013?

4 Stocks Ready for 2013

2 Timely Shale Plays

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