Lemons into lemonade: High yield stocks from today's market rout for tomorrow's retirement portfolio

09/16/2011 8:30 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

If you can look past the pain at your losses and the fear that--three years after the Lehman Bros. bankruptcy—the global financial system is about to meltdown again, the current market rout is an opportunity. It’s an especially important opportunity for investors who are within 10 years or so of retirement and who have been planning to use income from their portfolios to fund part of their retirement.

I don’t expect anyone to get giddy at this opportunity. It definitely falls in the “When life deals you lemons, make lemonade” category.

But if you can manage a long-term view that gets your thinking beyond the next quarter or two or three, you’ll realize that one of the biggest challenges facing anyone thinking about retirement is where to find decent yields—and that this sell off has created some very decent yields in some very good stocks.

It sure will be a lot easier to put enough money aside to produce the retirement income you need if it’s invested in something yielding 6% than if it’s invested in something yielding 2%. Here’s the math: If you want to generate $2,500 a month in income from a portfolio—that’s $30,000 a year—from 10-year Treasuries yielding 2% a year, you’ll need a portfolio of $1.5 million, but if you’ve invested in something paying 6%, then you’ll need a portfolio of just $500,000. That’s $1 million that you don’t have to save, that you can invest in growth stocks, that you can use for college tuitions, or that you can spend on a house in Tuscany or wherever. Get the idea?

That’s not the only reason to use this crunch as an opportunity to buy higher future yields. I’m also concerned with the likelihood that all the retiring boomers will start looking for income at about the same time. That could create the kind of intense competition for higher yields that bids those yields lower. Part of the reason to buy now is my worry that these higher yields will be extremely rare when everybody and his Aunt Tillie suddenly decides they need them for their portfolio.

I’m going to end this post with a list of five dividend-paying stocks that provide exactly this kind of yield now thanks to this not-so-wonderful sell off. (This list is necessarily going to be different from my Dividend Income portfolio http://jubakpicks.com/ That portfolio looks for income now—or at least income over the next 12 months or so. This list is looking to buy yield now for income in five to 10 years.)

But I’m going to begin with some general principles and caveats that should guide you in putting together your own portfolio of this kind.

  1. Make sure that you aren’t reaching for current yield but ignoring the risk to that yield in the future. It doesn’t do any good to buy a 6% dividend now, if the company is going to cut the dividend in the future so the higher yield isn’t going to be around when you need it in retirement in five to 10 years.

  2. While you’re doing your due diligence on company specific risk, don’t forget the larger macroeconomic risks such as inflation. I think retirement is likely to be extremely challenging to boomers because we’re looking at high odds for rising inflation in developed economies. (Yes, it is possible, I suppose, that governments in developed economies will balance their budgets instead of just printing more money. But I’m not counting on it.) Inflation will erode the value of your income stream—which is why I’m advising you to look for income from dividend paying stocks rather than fixed income bonds. Dividends can go up over time—a bond’s payout is fixed at the time it is issued. Ideally, you’d like to find a high yield from a company that is likely to raise dividends over time so that you can keep ahead of inflation.

  3. Don’t forget the basic rules of portfolio diversification when building this high yield future portfolio. Don’t overload with picks from one sector—even though financials offer an especially tempting target right now. Don’t concentrate on a single country or economic zone either.  Or currency. This kind of diversification is especially valuable in building a portfolio that’s supposed to pay off in five or 10 years. You’ll make mistakes; of course, you’re just trying to make sure that one mistake doesn’t take down the entire portfolio because everything in it is so much alike.

  4. The dollar isn’t likely to be a stable store of value over the time period I’m talking about. That’s the polite way of saying that persistent U.S. budget deficits, inflationary monetary policies, and slow economic growth will steadily erode the value of the U.S. dollar. The best way to fight this that I can see—given that gold doesn’t pay any dividends—is to put your income producing investments into the stronger currencies in the world. As the recent devaluation of the Swiss franc through a peg to the euro shows there aren’t any guarantees that today’s strong currency will be tomorrow’s strong currency. But we can increase the chances of getting that right by looking at currencies from commodity economies or where the central bank has been very reluctant to depreciate or where the national government has a history of running a fiscally responsible ship.

Because this last principle is so important, I am tempted to call this the “Strong currency dividend income portfolio.”

Now on to the picks in alphabetical order. The last time I visited this topic http://jubakpicks.com/2011/08/09/dividends-in-strong-currencies-a-strategy-that-fits-this-market/ on August 8 I gave you only two stocks—and one of those Svenska Handelsbanken was very thinly traded in U.S. markets (although not in Stockholm.) This go round I’m going to give you five (including the original two) and three of them have good liquidity in U.S. markets.

  • CPFL Energia (CPL in New York or CPFE3.BZ in Sao Paulo) is Brazil’s largest private utility with 13% of the national market. About 75% of operating income comes from regulated electricity sales with the company’s business concentrated in the economically strong Sao Paulo and Rio Grande do Sul states. It’s difficult at this point to say what the course of the Brazilian real will be over the next 10 years. The administration of President Dilma Rousseff shows signs of slipping back from recent progress on controlling budgets and inflation but I still think Brazil’s course is set toward credit rating upgrades and a solid currency. I wouldn’t overweight Brazilian stocks in a long-term income portfolio now but one, with a yield of 6.5%, seems a reasonable risk.

  • Keppel Land (KPPLF in New York and KPLD.SP in Singapore) is the property arm of Singapore’s Keppel Group. The company’s portfolio of Singapore properties includes office towers, resorts, hotels, residential properties, retail centers and industrial buildings. After the Swiss National Bank pegged the Swiss franc to the euro, there was a brief market flirtation with the Singapore dollar as an alternative before traders decided that the Singapore currency wasn’t liquid enough to handle their huge bets. But the assessment of the strength of the currency was correct. The shares now trade near a 52-week low and yield 6.1%.

  • Statoil (STO in New York and STL.NO in Oslo) gives you double protection against inflation and a sinking dollar. The oil company’s product—oil—is priced in dollars and goes up in price when the dollar falls. And Norway’s krone is backed by one of the world’s most fiscally cautious governments and central banks. The shares currently yield 5.1%.

  • Svenska Handelsbanken (SVNLF in New York and SHBA.SS in Stockholm).  Sweden’s second largest bank is the most conservatively run of Sweden’s banks with a history of extremely low loan losses. The bank’s Tier One capital ratio is 15%. The shares currently yield 6.1%. Sweden’s kroner is likely to stay one of the world’s stronger currencies: The central bank is on record saying that it doesn’t see the need to depress the currency even if Swedish exporters are complaining about losing customers because of the exchange rate.

  • Westpac Banking (WBK in New York or WBC.AU in Sydney) has taken a hit recently on fears that Australia’s commodity economy might slow with any pull back in China. That’s why you can get shares of Australia’s second largest bank by market cap at a 7.8% yield. A 4.4% pull back in the Australian dollar in the first half of this week has taken some of the short-term currency risk out of buying the shares—and the commodity link argues that the Australian dollar will be one of the world’s stronger currencies over the next 10 years. The bank had a Tier One capital ratio of 9.5% in March

Why not more than five

Many of the stocks that combine high yields with stock currencies only trade in their home markets (and very infrequently in the United States.) There’s Bradken, for example. This Australian manufacturer of mining supplies pays a 7.7% dividend, but the shares trade only in Sydney (BKN.AU).

And some of the stocks that look like they’d be natural for this portfolio aren’t guaranteed to keep their dividend payments at current levels for a 10-year period. Enerplus (ERF), for example, is an attractive Canadian producer of oil and natural gas from shale formations in Western Canada, North Dakota, Montana, and elsewhere. The company, which in 2010 converted from an income trust to a corporate structure, pays a 8.1% dividend yield, but the cash flow for that dividend comes from the conventional oil and gas assets that the company is selling off to get the capital to invest in its unconventional holdings. What’s the cash flow picture in 10 years? I can’t tell you.

So it is hard to find these opportunities. But I wanted to give you the ones I’d found so far.

And I’ll keep looking.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund owned shares of Statoil and Westpac Banking as of the end of June. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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