Time to Focus on Dividends

05/06/2011 9:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

As investors get more defensive, stocks with high dividends are starting to outperform. Ambev, Merck, and Abbott Laboratories are worth considering.

When markets get iffy, dividends look spiffy. (And, yes, I just made that up.)

I'm seeing evidence that investors are making a defensive shift, as the global growth story gets less certain and as more central banks embark on cycles of interest-rate increases to fight inflation.

From August 2010 until this February, energy, materials, cyclical manufacturing, and commodity stocks led the market. Defensive sectors, such as utilities, consumer staples, and health care, lagged behind.

That changed at the beginning of April. Energy and commodity stocks have started to underperform. In April, health care, consumer staples, and utilities outperformed.

Let's compare two stocks: miner Freeport McMoRan Copper & Gold (FCX) and major drugmaker Abbott Laboratories (ABT).

  • In 2010, Freeport McMoRan killed. The shares returned 51.94%, far better than the 15.06% return on the S&P 500.
  • Abbott got killed. The stock returned a negative 8.08% for the year. That's more than 23 percentage points worse than the S&P 500.

Over the last month? It's just one month, so Freeport McMoRan can't be said to have collapsed, but the stock has lost 2.96%. Abbott stock, on the other hand, did kill. It returned 8.02% for the month.

Whistle "The World Turned Upside Down" if you know it.

And it's not just Abbott. Merck (MRK), a drug stock that went nowhere in 2010 (total return: 2.79%, and that was all due to the dividend), climbed 10.1% in just the last month. The major drugmakers as a whole were up 8.7%.

Sectors like consumer staples, health care, and utilities are attractive to investors when the market seems risky, because the stock prices at these companies tend to hold up better than, say, the price of a technology or cyclical mining stock.

That's because revenue and earnings in those sectors hold up relatively well when the economy hiccups. (When the economy goes into crisis, nothing holds up especially well, unfortunately.)

It also helps that these defensive stocks pay dividends—and relatively high dividends at that.

Merck's stock price may not have shown a gain for 2010, for example, but the stock's better-than-4% dividend pushed the total return for that year to 2.79%. Better than a money market, and better than the yield on most Treasurys.

NEXT: Where My Dividend Portfolio Has Been

|pagebreak|

Where My Dividend Portfolio Has Been
This is the background for my latest revision of my dividend income portfolio.

I last did a major overhaul of my picks for the best dividend stocks on May 28, 2010 (although I added Intel (INTC) to the portfolio in September).

The environment then was very different. A lot of stocks were still selling at depressed prices, and therefore offering exceptionally juicy dividend yields.

In that update, I added Banco Santander (STD), yielding 8.5%, and Total (TOT), yielding 6.5%. Those two picks have done more than OK. Besides their hefty dividend payouts over the last year, the stocks have appreciated in price by 20.9% and 32.1% respectively. (To see how the entire portfolio has done since its re-launch in October 2009 and since May 2010, go to the top of the portfolio page for my dividend income portfolio.)

But now, we're looking at a stock market that has rallied pretty much non-stop for the last year, so many of the hefty yields of yesterday have turned into much more modest payouts.

Banco Santander, thanks to the euro debt crisis, still pays 6.87%, but the yield on Total is down to 4.65%. For Intel, which I added when the stock was yielding 3.4%, a 24.4% gain in price since September 2010 has taken the yield down to 2.84%.

I need to replace certain stocks—those that have done so well in terms of price appreciation that their dividend yield is now relatively paltry—with something that pays better.

How much better? If you'll remember, the original goal when I set up this portfolio was to find a stock that would appreciate in price and pay more in income than the current yield on the ten-year US Treasury.

That's a moving target, of course. When I added Intel to this portfolio in September, the yield on the ten-year Treasury was just 2.75%. As I write this, the ten-year Treasury pays 3.22%. I certainly want to beat that with every stock in this portfolio.

I'm still searching for that elusive free lunch, so I can't promise you some mythical combination of a yield higher than that on a ten-year Treasury but with less risk. Higher yields always come with more risk. My goal in this portfolio is to minimize that extra risk with good stock picking.

  • Sometimes that works: Banco Santander has clearly been less risky—so far—than its 8.5% yield in May 2010 indicated.
  • Sometimes it doesn't work: Telkom Indonesia (TLK) is down 4.03% since I added it to this portfolio in February 2010. That pretty much wiped out any dividend payments during the last year, plus some.

NEXT: Where My Dividend Portfolio Is Going

|pagebreak|

Where My Dividend Portfolio Is Going
Today, if I read the market and economy correctly, I think you can find yields better than the ten-year Treasury—with less than the perceived risk—in the defensive sectors that I mentioned at the top of this column.

These sectors lagged through all of 2010, so yields are relatively high. But it looks like the market and economic cycles have turned in a way that gives these stocks a good chance to appreciate in 2011.

So what exactly am I dropping from the portfolio today? And what am I adding?
 
As you might expect from the above, I'm dropping both Intel and Telkom Indonesia. Intel is going because the price appreciation in the stock has reduced the yield below my goal. And I'm dropping Telkom Indonesia because at this moment I think an emerging-market telephone company is sufficiently risky that it should be paying more than a 3.56% yield.

I'm also dropping Navios Maritime Partners (NMM) from this portfolio, despite its high 10.4% yield. This is an extremely volatile stock, sensitive to shifts in the growth rate of the global economy.

The stock was up 17.9% from March 18 to April 28. It has been weakening since then on the increase in worries about global growth. I'm happy to take that profit.

My adds to replace those stocks include Ambev (ABV), which I'm moving from my Jubak's Picks portfolio to this list on expectations of slower earnings growth. The stock pays a dividend of 3.75%. That, plus the prospects of modest earnings growth (slower growth, as opposed to no growth) make this very stable consumer stock a good fit with this portfolio.

I'm also adding two drug company stocks to this list: Abbott, with a 3.4% yield, and Merck, with a 4.1% yield. I think both of these stocks stand a good chance of gaining in price thanks to US investors' current search for safety.

Visit my dividend income portfolio site over the next day or two for more complete explanations for each of these buys and sells.

Full disclosure: I don’t own shares of any of the companies mentioned in this column in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. The fund did own shares of Banco Santander and Freeport McMoRan Copper & Gold as of the end of March. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.

More from MoneyShow.com:

Related Articles on STOCKS