Easy Pickings for Dividend Income

05/28/2010 10:14 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The recent market decline has uncovered some surprising finds. If yield is the name of the game (isn't it always?), the Jubak dividend income portfolio is ready for an update.

Once upon a time, I worked in an office beneath a sign that read, "We're a nonprofit company...but we didn't plan it that way."

I'm reminded of that as I write this week about all the wonderful buys this market correction has created for dividend income investors.

I'm a dividend income bargain hunter…but I didn't plan it that way.

Here's why: I think the bargains in this market are too amazing to pass up. The 12% drop (as of May 25) in the Standard & Poor's 500 Index from the April 23 high has pushed up yields to the point that some stocks I never thought I'd put in my dividend income portfolio are begging to join it: Intel (Nasdaq: INTC), yielding 3.1%; Nucor (NYSE: NUE), at 3.4%; Nokia (NYSE: NOK), at 4.3%; and Taiwan Semiconductor Manufacturing (NYSE: TSM), at 3.7%. But why not when a ten-year Treasury is yielding just 3.15%?

If I can find yields like that by just rolling out of bed and over to my computer, think what a little digging will do.

Greedy for Yield

You remember the rules of the dividend income portfolio, right? The goal is to beat the yield on the ten-year Treasury with the dividend from a common stock (or its near equivalent). By sticking to common stocks, for which the dividends rise over time (if you pick the right stocks) -- unlike bonds, for which the coupon interest rates are fixed at issue -- I gained an edge against any return of inflation or higher interest rates.

A stock such as Verizon (NYSE: VZ), for example, which has grown its dividend payout by almost 4% a year over the past five years, provides good protection for income investors against rising interest rates.

Of course, while the rules of the portfolio may not change, market conditions do. Right now, because of the euro debt crisis, it doesn't look like income investors need to worry about inflation or higher interest rates anytime soon. And right now, stocks are demonstrating, for anyone who had forgotten (ha!), that stocks are risky and volatile. So in adding to the portfolio now, I'm a little less concerned about avoiding interest rate increases and a little more concerned with getting more yield—a lot more yield—than I'd get with a much-less-risky Treasury note.

So I'm looking for a stock or two that will beat not just the 3.15% yield on the ten-year Treasury, but also the 4.28% yield on Rayonier (NYSE: RYN) and the 4.63% yield on DuPont (NYSE: DD). They're the lowest-yielding stocks in the portfolio aside from Telkom Indonesia (NYSE: TLK), but I think that stock has more upside in any end-of-2010 recovery from the current emerging market selloff.

OK. If I'm selling Rayonier and DuPont out of the dividend income portfolio, what am I replacing them with? (I'm also selling Rayonier out of the Jubak's Picks portfolio. You'll find more detail on that sell Friday.)

There are high-yielding stocks that I think are just too risky. Deutsche Telekom (NYSE: DT), for example, yields 9.6% now, but its wireless business is struggling, and I don't see a turnaround as likely. Barnes & Noble (NYSE: BKS) yields 5.2%, but, well, you know what's going on in the book business these days.

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On the other hand, I would say that Spain's Banco Santander (NYSE: STD) isn't as risky as it seems, and the American depositary receipt's 8.5% yield amply compensates me for that risk. Banco Santander looks like it's going to emerge as one of the winners of Spain's banking crisis.

Spain's big banks have lost market share in the past two years to regional banks that have kept on making real estate loans even as the risk of those loans defaulting was climbing. Now those regional banks are in deep, deep trouble, and the Bank of Spain, the nation's central bank, has begun shutting the worst of them and forcing others to combine. I think that will put business back in the hands of Banco Santander and Banco Bilbao Vizcaya Argentaria (NYSE: BBVA). The dividend yield on Banco Bilbao is just 6.2%. (For more on the state of banking in Spain in particular and Europe in general, see this blog post.)

(Most U.S. banks haven't yet restored the dividends on their common stock that they were forced to cut when they took taxpayer cash in the post-Lehman Brothers bailouts. I have found one interesting play among the US group—although since it's not a common stock, it doesn't fit in my dividend income portfolio. But it might fit in yours, so let me mention it. The security is JPMorgan Chase, 8.625% Non-Cumulative Preferred Shares (NYSE: JPM-I). At Charles Schwab, where I bought some recently, the symbol is JPM+I. The CUSIP number is 46625H621. The preferred shares were issued with a coupon rate of 8.625%. On May 25, they were trading slightly above the par value of $25, so the yield was about 7.9%. The shares have traded as high as $29 recently, and I wouldn't buy there, since they could be called away from investors at $25 as early as September 2013. But if you can buy the shares near $25 or $26, I think the yield and the potential capital gain from any reduction in sector risk make the shares attractive.)

For my second pick, I'm going for a class of stock even more in the doghouse than a European bank stock: It's Total (NYSE: TOT), a European oil stock. Shares have dropped from $65 at the beginning of 2010 to $45 now. That's driven the yield up to 6.5%, considerably above the yields for US-based oil companies such as Chevron (NYSE: CVX), at 3.8%.

The company increased production in the first quarter by 6%, and, while its refinery business is running way below capacity (and it being in France, Total faces intense political pressure not to close any refineries), its chemical unit has enjoyed the same cost savings and demand recovery that have buoyed stocks such as DuPont.

With any oil company these days, an income investor has to ask how safe is the dividend if oil prices continue to fall or just stay at today's depressed levels. Total finished the first quarter with a modest 34% debt-to-equity ratio and with $17 billion in cash and cash equivalents on its balance sheet. That dividend looks secure to me.

Worth the Wait

Let me spell out the assumptions behind making any picks right now. Yes, stocks can continue to go down in price, and my guess is that until the markets can put the euro debt crisis and fears of a growth slowdown in China in the past, stocks will have a hard time moving up. (For more on my view of the market right now, see this blog post.)

But with a dividend income play, you are being paid to wait. At least as long as the company is financially sound enough so that it can survive the turmoil without cutting its dividend or worse.

And, of course, if you've picked the right high-yield stocks, then after you've waited, collecting your dividends, for long enough, you should be rewarded with tasty capital appreciation.

At the time of publication, Jim Jubak owned shares of the following companies mentioned in this column: Banco Santander, JPMorgan Chase, and Rayonier.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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