8/13/2013 2:30 PM ET|
Dump Wal-Mart, Coke, Caterpillar?
Investors should be wary of sleepy dividend stocks with low growth prospects ahead of any move by the Federal Reserve to reduce its buying of Treasurys and mortgage-backed securities.
As Wall Street continues to eye tighter central bank policy in the medium term, it's important for investors to be proactive about their portfolios and avoid stocks that could be shaken up by Federal Reserve actions in the next few months.
And one area of risk right now are sleepy dividend stocks with low growth prospects, which have been overly reliant on buying from income investors over the last few years.
As rates tick higher, it will be harder for many investors to justify dividend stocks as their best low-risk investment when Treasurys begin to yield as much or more. As long as the market is booming it's OK for these picks to slightly underperform, but if the market is flat and Treasurys yield more?
Well, there's not much point.
The 10-year T-Note saw its yield soar from 1.63% on May 2 to as high as 2.72% a week or so ago. So in my mind, any stock yielding less than 3% better have a pretty story or else it doesn't make sense for low-risk portfolios.
Here are three dividend stocks at risk in a higher interest rate environment as investors seek other options for low-risk income trades:
Wal-Mart Stores (WMT) is the world's biggest retailer, and certainly enjoys scale and a degree of stability from that reach. But stability is not growth -- and if investors can get a comparable dividend elsewhere, why mess with Wal-Mart?
In its May earnings, Wal-Mart saw U.S. same-store sales slip for the first time in almost two years, an uncomfortable reminder of the bleak run from 2009 to 2011 that featured an ugly streak of nine consecutive quarters of declining same-store sales.
The retailer reports its quarterly financial results next week, and it better show some strength or investors will get jittery. Heavy spending to enter overseas markets must begin paying off or else the narrative of sales struggles will again take center stage.
Some investors may have bought the company's excuses about weather and tax-refund checks in May, but Wal-Mart isn't going to get a pass if it posts another weak quarter.
The stock has only slightly underperformed in 2013, with a 12.4% return year to date, so there are worse things in the world than being a Wal-Mart investor this year. But after setting a high near $80 in right before that quarterly sales miss, the stock hasn't challenged that level for some time. That's telling.
With just a 2.4% yield, considerably below 10-year Treasurys right now, low-risk investors may be better served taking money off the table.
Coca-Cola (KO), like Wal-Mart, has a powerful brand and an enormous reach. Couple that with the 2.8% dividend yield and a massive portion of shares held by Berkshire Hathaway (BRK.B) and investing icon Warren Buffett, and it seems natural to call Coke "low risk."
However, this stock shares some unfortunate truths with Wal-Mart . It also has underperformed in 2013, with just a 9.6 year-to-date gain s vs.18.4% for the Standard & Poor's 500 Index ($INX) since January. And Coke shares the same excuses about wet weather sapping sales, something that bought it another quarter with patient investors. But that won't stand up if it misses earnings down the road.
Coke's North American sales volume has slipped for the first time in 13 quarters as soda consumption continues to dry up. The move toward healthier eating habits continues to squeeze Coke stock; that's not a story about the weather but changing consumer tastes.
It's also worth noting that a strong dollar isn't good for Coke; it is estimated to shave 4% of the multinational's operating profit this fiscal year. Tighter Fed policy could prop up the dollar more, accelerating this problem.
The 2.8% dividend is nice, and reliable -- a yield has been paid in some form dating to 1893. But Treasurys seem a much more stable bet for low-risk investors if rates stay elevated.
Heavy equipment manufacturer Caterpillar (CAT) yields more than 2.9% at current valuations and has over $65 billion in annual revenue. But it's far from a safe bet.
Shares are off 3% this year, largely due to three straight earnings misses. In January it was a big writedown thanks to fraud at a Chinese company it acquired. More recently, revenue weakness has dogged Caterpillar as the global mining boom that drove earnings in the wake of the financial crisis has begun to taper off as commodity prices crash thanks to an economic slowdown in China.
And, like it or not, commodity stocks and related businesses like Caterpillar have been left out of the rally in 2013 … and could continue to sit out for a while.
Don't be lured in by the 2.9% dividend. 10-year Treasurys aren't far behind, and have a much more stable outlook.
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What this aritcle ignores is that historically stocks such as Coke increase their dividend virtually every year. If you start out with a yield of 2.5% today and the company increases its dividend by 5% per year, in 5 years your cash yield is 3.125% on your original cost. With Treasuries, your cash interest yield is fixed for the life of the bond. Add to that the lower Federal tax rate on dividends than on interest income, and high quality dividend paying stocks are hard to beat if you are an income investor.
I guess it is no secret but just because the market is up it doesn't mean your stocks are up. It is a select few stocks that have taken the market up and if you didn't own those particular ones you most likely didn't make a lot of money.
The market is fickle and just waiting for a reason to go down and I am sure it is coming. Be ready to move when it does. If taking the interest rates up will help us pay off debt we better do it. There is still a lot of unemployment but there are help wanted signs everwhere. If you can get up to 99 weeks unemployment and you don't want to work, why should you. This needs to stop. Now you can also get free medical along with everything else. Why work? Wake up America!
As it is, should the Fed really take serious initiative to curb its stimuli, there will be much more to worry about than just "sleepy dividend stocks." The growth stocks might well be hurt much more.
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