The Miracle of “Unfixed Income” Investing

04/21/2008 12:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Jim Jubak, senior markets editor for MSN Money, says stocks that raise their dividends are good bets in today’s markets, and he recommends one bank stock in particular.

These are excruciating times for fixed-income investors. In the current market, risk is up and yield is down. It's hard to see how higher inflation and rising interest rates won't eat away at the value of today's investments.

But I think there's a way out that will enable you to keep up with inflation—and more—and that will let you grow the yields of your income investments over time. I'm calling this miracle strategy "unfixed-income" investing.

This strategy starts with common stocks that pay high dividends—yields above the percentage paid by the ten-year Treasury note—and that are safer than the ten-year Treasury under current market conditions.

In a period when yields have been falling, my dividend-stocks portfolio has returned an annualized 13.5%—that's dividends plus price appreciation (if any), minus commissions. That stacks up nicely against the 5.8% average annual return (with dividends) on the Standard & Poor's 500 Index for the period that ended April 8th.

But for my unfixed-income strategy, I'm going to add a third criterion: superior histories of raising dividends year in and year out. This gives income investors a fighting chance to beat today's low yields and stay ahead of future inflation by putting the power of dividend compounding to work for long-term-income investors.

US Bancorp (NYSE: USB) is my first pick for my unfixed-income portfolio. [Its] yield—5.24% on April 10th—is certainly high enough to make the cut.

The company did take a $115-million ding when it bought back some debt securities owned by its money market funds, but that's been about the extent of the damage in the current financial crisis. Analysts expect charge-offs for bad loans could grow to 1% of total loans this year and next.

With a Tier 1 capital ratio of 8.3%, US Bancorp ranks as one of the best-capitalized banks in the US market. The company's well-run consumer-banking business will gain market share thanks to the sector's turmoil. [And] because the bank doesn't have big problems with mortgages or home-equity loans, it's making new loans while other banks are cutting lending to conserve capital.

But [that’s] low enough to convince me that the bank will ride through the downturn in housing and commercial lending without any big problems. This is one of the most profitable banks in the country, with return on equity well above 20% year in and year out.

But it is US Bancorp's commitment to returning 80% of earnings to shareholders that makes it the first stock in my unfixed-income portfolio. Combine that with the bank's steady rate of earnings growth—8.5% annually over the past five years—and you get a stock with constantly increasing dividends for shareholders.

In 2003, the stock paid 86 cents a share in dividends. For 2008, the dividend payment has climbed steadily to $1.70 a share, an increase of 98%. (The stock closed below $34 Friday, and it yielded 5.1%—Editor.)

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