How to Pick Stocks in an Ugly Market

08/09/2011 9:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Given the turbulent markets, cash may seem like the best place to be. But if you’re willing to take a little risk for a chance at higher returns, look for a dividend stock with a currency kicker.

What if you can’t muster the optimism to buy beaten-up growth stocks today—and yet you’re not so pessimistic that you’re out in the backyard burying gold?

Over the weekend, I’ve been thinking about stocks that pay dividends, but in some currency other than dollars. It strikes me as an attractive combination. Today I’m going to add a bit of that combination to my Dividend Income portfolio.

You have to have a degree of long-term optimism to buy growth stocks during the current global sell-off.

And maybe you don’t right now—what with the continuing euro debt crisis, the downgrade of US debt to AA from AAA by Standard & Poor’s, and stock-market reaction Monday that had a whiff of panic. Quite possibly this doesn’t feel like a time to be buying any of the stocks I picked in my Friday column.

Maybe you can muster a degree of long-term optimism, but the short term looks very dark. And you’re not sure how long that short term will last—a few days, or a few weeks? In that case, sitting on cash feels like the right thing to do.

Buy some gold? Gold topped $1,700 an ounce Monday. It’s probably still a good hedge—if the next stop is $2,000, that’s a 17% gain from here. But it’s expensive, and carries its own risk of a correction. Plus, it has the drawback of not paying any yield.

Bonds? Certainly not US Treasuries, as everyone tries to figure out the ramifications of the US downgrade.

Because I don’t know how long current market conditions might last, I recommend you think about safety, certainly...but safety that pays a little bit. And that’s led me to what I’m calling a safe, currency-enhanced dividend play.

For example, I’ve been thinking a dividend yield of 3.47% on shares of DuPont (DD) looks attractive, compared with the 2.34% yield on the ten-year US Treasury. Sure, DuPont is rated just A for the long term by S&P. But that A looks a little better today than it looked when the US was AAA just last Friday.

The Beauty of a Dividend Not in Dollars
The one thing that troubles me about DuPont, though, is that this US-based (but global) company does business and pays its dividends in dollars.

When it comes to doing business around the world, a weak dollar that promises to become weaker is a mixed blessing. It certainly gives a US company a pricing edge against competitors that sell in stronger currencies. (I’d hate to be a chemical company selling its goods in Swiss francs right now, for example.)

On the other hand, it also raises the cost of raw materials, especially those that aren’t priced in dollars. I don’t think you can call a weaker dollar a plus or a minus for all US companies. Which it is and how much depends on a specific company’s mix of business.

But there’s no doubt that, all else being equal, I’d prefer if DuPont paid me its dividend in something other than dollars. If the dollar continues to weaken, that dollar-denominated dividend stream will be worth a little less each day.

What would I prefer? Not euros or yen, certainly. But there are still strong currencies in the world. Swiss francs. Canadian and Australian dollars. The Swedish krona and the Norwegian krone.

With each drop in the dollar, euro or yen, the value of dividend streams from companies doing business in these currencies increases to anyone collecting those dividends in a weak-currency country.

That’s not to say that you should pile into just any strong-currency dividend stock. Remember that a strong currency is a mixed blessing for the company doing business in that currency.

A Swedish manufacturer going head to head with a US manufacturer is facing a competitor able to sell its goods for less to many customers every time the dollar falls. At the same time, the goods of the Swedish manufacturer get just a little more expensive to many customers every time the krona appreciates.

If you want to see the damage that having to compete in a strong currency can do to companies, just take a look at the devastation in Brazil’s goods exporting sector from the strong real.

NEXT: The One Top Dividend Choice

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Nestlé Is a Near Miss
So, again, you need to look at the pluses and minuses of a strong currency on any company.

I like Nestlé’s (NSRGY) 3.49% yield paid in Swiss francs, for example. But I worry about the pressure a strong franc puts on the company’s prices around the world. (The degree to which Nestlé produces its products locally mitigates some of the competitive disadvantages of a strong Swiss franc.)

So what would be my ideal strong-currency dividend stock—besides the obviously strong-currency bit, of course?

As always with my dividend portfolio, I’d like the stock to yield more than the ten-year Treasury (now at 2.34% or so.)

I’d like the company’s business and balance sheet to be safe and solid enough that I’d be unlikely to see a cut in dividend anytime soon. And I’d certainly prefer not to give back in a sinking share price what I pick up in dividend yield.

And I’d like a mix of businesses that maximizes the benefits of a strong currency to me, the shareholder, while minimizing the competitive pain to the company whose shares I hold. Stocks like this aren’t easy to find, I’ll admit.

AmBev (ABV), which I added to the dividend portfolio on May 6, has a great many of these characteristics (including a 4.9% dividend yield), but I worry that the Brazilian real is overpriced after its huge appreciation against the dollar, given the current problems in the Brazilian economy.

Australia’s Westpac Banking (WBK in New York and WBC.AU in Sydney), with its 7.64% yield, makes the grade, I think, although investors might have to sit tight through some turbulence in the Australian economy, as the central bank tries to fine-tune interest rates and inflation.

My First Choice
The most attractive combination that I’ve found recently is Svenska Handelsbanken (SVNLF in New York and SHBA.SS in Stockholm).

This is the most conservatively run of Sweden’s banks, and it has a history of extremely low loan losses. In July, the cost of protecting the bank’s own debt against default in the credit-default swaps market was the second lowest in the world, among 197 banks tracked by Bloomberg.

The bank’s Tier 1 capital ratio is 15%, and the bank earns a 15% return on equity. The shares of Sweden’s second-largest bank (60% of profits come from the Swedish market) pay a yield of 4.9%, and trade at 9.9 times trailing 12-month earnings. I’m adding the stock to my Dividend Income portfolio today.

And I’m going to keep looking for strong-currency dividend income stocks. I don’t think the decline in the dollar—and the yen and euro—is a short-term trend. Adding a bit more exposure to strong-currency dividend flows strikes me as a good long-term strategy for getting a bit more return in a world where decent returns seem very hard to come by.

At the time of publication, Jim Jubak did not own or control shares of any of the companies mentioned in this column in his personal portfolio. The mutual fund he manages, 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 Westpac Banking as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.

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