Dividend stocks to consider

Fearing the fiscal cliff-associated tax hikes, many investors have been dumping dividend stocks. They may have been making a big mistake.

By John Reese Jan 2, 2013 11:10AM
Stock market report Don Carstens JupiterimagesIn the months leading up to the fiscal deal, high-dividend stocks have been taking some hits. High-yield stocks have lost an average of 2.89% over the past three months, according to Morningstar.com, the worst performance of any of the eight types of stocks that the research site tracks. While fiscal cliff and higher taxes on dividends may not be the only reason, no doubt these concerns were playing some role in dividend stocks' sluggishness.

Those declines, however, have shaken some of the excess bullish sentiment out of high dividend plays, which had gotten fairly pricey earlier this year as investors, starved for yield in the current low-interest-rate environment, flocked to them. What's more, there's some intriguing research showing that, historically, high-dividend stocks haven't suffered when dividend taxes have been high or increasing dramatically.

 

The research comes from O'Shaughnessy Asset Management, the firm headed by quantitative investing guru James O'Shaughnessy. Looking at stock returns from 1926-2011, OSAM found that high-dividend stocks outperformed the broader market by just about the same margin, on average, during periods when dividends were taxed as regular income, periods when dividends were exempt from taxation, and periods when dividends were taxed at 15%. The group found just one example of a dividend tax increase in the neighborhood of what the fiscal cliff could cause (1953-54), and found that high-dividend stocks actually outperformed following that increase.

 

Several of my Guru Strategies, which are based on the approaches of some of history's greatest investors (including O'Shaughnessy) use dividend yield as a key metric in picking stocks. Right now, they are finding a number of very attractive high-dividend stocks in the market. Here's a look at some of the best of the bunch. While other fearful investors run away from high-yielding stocks like these, you might be wise to consider adding some to a well-diversified portfolio.

 

Vale SA (VALE): This Brazil-based metals and mining company operates in more than 38 countries, with mineral exploration activities in 21 countries.

 

Vale's shares have started to turn around after a long decline, perhaps because of signs China -- a huge consumer of Vale's mining materials -- is rebounding. Vale has a 5.3% dividend yield, which catches the eye of my O'Shaughnessy-based value model. The approach also likes Vale's size ($110 billion market cap, $48 billion in trailing 12-month sales) and solid $3.03 in cash flow per share.

 

Total S.A. (TOT): This Paris-based oil and gas giant has operations in more than 130 countries. The $122-billion-market-cap firm has taken in nearly a quarter-billion in sales over the past 12 months.

 

My O'Shaughnessy-based is high on Total, which current offers a 5.8% dividend yield. It likes Total's size, that high yield, and Total's $11.35 in cash flow per share.

 

My David Dreman-based contrarian model has some interest in Total. Dreman focused on beaten-down stocks whose fundamentals indicated they were too beaten-down. This strategy considers Total a contrarian play because its price-to-earnings, price-to-dividend, and price-to-cash flow ratios all fall into the market's bottom 20%. Given that it also has 13.6% pre-tax profit margins, and that high dividend yield, the model thinks it's worth a long, hard look.

 

AstraZeneca (AZN): Based in London, AstraZeneca is one of the world's largest drugmakers. The $58-billion-market-cap company is active in more than 100 countries, and makes a variety of well-known medications.

 

AstraZeneca is a favorite of my Lynch and Warren Buffett models, in part because of its stellar 6.1% dividend yield. The Lynch-based approach likes its solid 17.3% long-term growth rate and 0.41 yield-adjusted price-to-earnings-to-growth ratio (P/E ratio divided by the sum of the growth rate and dividend yield).


The Buffett approach, meanwhile, looks for firms with lengthy histories of earnings growth, manageable debt, and high returns on equity (which is a sign of the "durable competitive advantage" Buffett is known to seek). AstraZeneca delivers on all fronts. Its earnings per share have dipped in only two of the past ten years; it could pay off its $9.3 billion in debt in less than two years if it wanted to, given its $6.1 billion in annual earnings; and its 10-year average return on equity is an impressive 31.5%. 

 

Royal Dutch Shell (RDS.A): This Netherlands-based energy giant is one of the largest firms in the world, with a $223 billion market cap and close to half a trillion dollars in sales over the past 12 months. It's paying a 5.0% dividend yield, part of the reason it gets approval from my O'Shaughnessy-based value model. When looking for value plays, O'Shaughnessy targeted large firms with strong cash flows and high dividend yields. Shell is certainly big enough, and that high yield and its $12.48 in cash flow per share (about nine times the market mean) also earn it high marks from the strategy.

 

NTT Docomo (DCM): Based in Japan, NTT Docomo is a mobile telecommunication company ($63 billion market cap) that gets high marks from my Benjamin Graham- and O'Shaughnessy-based models. Currently, it has a 5% yield, one reason it gets strong interest from my O'Shaughnessy-based value model. Another reason: its solid $3.04 in cash flow per share.


My Graham-based model, meanwhile, likes that the firm has about seven times as much in net current assets ($14.9 billion) as it does long-term debt ($2.1 billion), and that it has a 2.2 current ratio (a sign of good liquidity). Graham is known as the "Father of Value Investing", so this approach likes that Docomo shares trade for 11.4 times trailing 12-month earnings and 0.98 times book value.

 

I'm long VALE, TOT, and DCM.


John Reese is founder and CEO of Validea Capital Management and Validea.com, a premium investment research site, and the author of "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies". 

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