Submitted by
Fast
Graphs
as part of our
contributors program
.
This article is Part 3 of a series of articles focusing on
finding value in the S&P 500 today. In Part 1, we laid
out several classifications of equities that comprise the S&P
500. In our follow-ups we are focusing on each of these
classifications one at a time, in order to focus on finding fair
valuation within each category. There's a lot of discussion,
much of it suggesting that stocks are overvalued today. We
disagree, because we conducted a thorough examination of each of
the S&P 500 constituents, we did indeed find a lot of value in
this market. Here is a
link to Part 1,
where we laid out our thesis of a market of stocks rather than the
stock market, and identified the categories that we are writing
about in these subsequent articles.
In Part 2 we focus exclusively on high-growth stocks that
are constituents of the S&P 500 and we believed were fairly
valued today.
In this part 3, we turn our attention to the highest yielding
stocks that are constituents on the S&P 500. However, we
submit that there are essentially two primary reasons that explain
why these stocks offer such high yields. The most prominent
is that these are low growth entities that need to offer high
dividend yields in order to attract investors. The next most
prominent reason is that some of these entities have seen their
stock prices collapse because of fundamental issues and challenges
within their respective business models. Consequently, their
high yields could be either a temporary illusion that will soon
change, or perhaps indicative of high risk.
Therefore, we submit that the moral of this story is that
everything is not all that it often appears to be. High yield
is nice, but if it also implies high risk, the investor has to be
prepared to factor that into their decision-making process.
In other words, the prospective investor has to decide whether or
not the reward is worth the risk taken to achieve it.
We have identified 17 companies in the S&P 500 that offer a
yield of 5% or greater. We then broke this down into two
sets, one that we felt had higher risk, and one that we felt
represents good opportunities for the investor either seeking high
yield, or high yield plus growth. It is very important to
state that this is a prescreened list based solely on organizing
the S&P 500 by order of highest dividend yield to the lowest
utilizing the
F.A.S.T. Graphs
™
fundamental analyzer software tool. Then we ran individual earnings
and price correlated graphs on each of our 17 selections in order
to sort them by risk.
More importantly, the reader should understand that we are not
recommending any of these selections. Nor are we suggesting
that any of these selections should be avoided. Instead, we are
offering both lists for the sole purpose of providing the reader
with a selection of S&P 500 high yielding constituents that may
be worthy of further due diligence and research. On the other
hand, we hope that the reader finds it useful to have both lists
sorted by apparent risk, based on fundamentals.
High Risk-High Yield S&P 500 Constituents
We do not believe it is a coincidence that our high-risk list
contains most of the highest yielding S&P 500
constituents. In today's interest rate environment, the
prudent investor needs to proceed with caution when they see yields
that are significantly higher than the current environment
generally is offering. On the other hand, given that the
market can often improperly appraise the price of a stock, an
aberrantly high-yielding security should not be immediately
rejected either. There is always the possibility that a more
comprehensive research effort may uncover a great long-term
opportunity.
The following table lists nine high yielding S&P 500
constituents that we believe should be carefully evaluated and
scrutinized. With many of the selections, further examination will
show that there are current issues with the companies'
profitability. In other words, some of the selections are
experiencing deteriorating earnings for one various reason or
another. Consequently, dividend cuts or even price erosion
should be considered as real possibilities. In other cases,
there are valuation issues, or more precisely, overvaluation issues
that need to be evaluated. Later we will provide a more
detailed example of both for illustration purposes.
Windstream Corp. (
WIN
)
Our first example reveals a telecommunications company that has
experienced a lot of earnings pressure.
Windstream Corp. provides high-speed broadband Internet, phone
service and Digital TV packages to residential customers as well as
products and services for small, medium and large businesses, and
government agencies. Windstream Corp. was formed from the spinoff
of Alltel Corporation's landline business and merger with VALOR
Communications Group, Inc.
As can be clearly seen from the following earnings and price
correlated F.A.S.T. Graphs ™ , due to the challenges of its legacy
wire line business, Windstream Corp. has experienced a steady
erosion of its earnings. Consequently, we believe that the
risk of a dividend cut is high, and therefore, investors should be
cautioned not to be too enamored with its high yield.
As you review the performance of Windstream, there are two
important concerns that need to be considered. First, note
that as earnings have eroded, so has the principal value.
Second, the current high payout ratio should serve as a red flag
warning about the viability of its dividend long-term.
Health Care REIT Inc. (
HCN
)
Health Care REIT, Inc. is a real estate investment trust that
has been at the forefront of senior living and health care real
estate since the company was founded in 1970. Since REITs are
primarily based on their ability to generate dividends, the reader
should note that the following F.A.S.T. Graphs ™ represents a Funds
From Operations (FFO) and price correlated graph instead of
earnings and price.
Consequently, what we see here is a very stable REIT; however,
history also shows that there hasn't been a lot of growth.
But most importantly, the reader should notice that the company is
currently trading at the highest valuation relative to Funds From
Operations (FFO), its normal price to FFO, and its cash flow
capability (the light purple line).
There is another good way to assess the current valuation of a
REIT by evaluating its current dividend yield relative to
historical norms. In other words, if Health Care REIT Inc.
was trading at a more historically normal valuation, its current
yield would be higher than the 5% it currently offers. All
this suggests is that today's moderate overvaluation may limit both
the total income and capital appreciation potential that the risk
of owning this REIT would justify.
Moderate to Low Risk High Yield S&P 500
Constituents
Our second list of high yield S&P 500 constituents appear to
offer their yields at lower levels of risk than our first list.
However, the reader should be cautioned that it is only based on a
prescreened review of the earnings and price correlation.
Therefore, it is also possible that some of the companies on this
list may also be of higher risk than many investors may be willing
to accept. As always, a more comprehensive due diligence
effort is suggested before any buy or sell decisions are made.
Lorillard Inc. (
LO
)
Lorillard is the third-largest cigarette manufacturer in the
United States. And from the earnings and price correlated
graphic below we discover that, like it or not, tobacco is a growth
business. Consequently, it appears that Lorillard offers the
conservative dividend growth investor the best of all possible
worlds. Historically this company has generated above-average
growth, an above-average yield and can be purchased at a sound
valuation.
TECO Energy, Inc. (
TE
)
TECO Energy is a Tampa, Florida-based utility with a reasonably
stable record of producing above-average yields and moderate growth
for shareholders. Currently, the company appears to be
trading at historically sound valuation relative to its earnings
power. However, the primary allure here is the above-average
dividend yield.
Summary and Conclusions
Although the primary focus of this article was to review the
highest yielding opportunities in the S&P 500, it provides a
secondary illustration that it is a market of stocks and not a
stock market. From the examples we reviewed, it should be
clear that there are significant differences between the actual
individual constituents of the S&P 500. Even though they
all share membership in the same fraternity, each company is an
individual in its own right. Moreover, even when they share
similar attributes such as yields, etc., there can be great
differences in the reliability and safety that these similar
numbers represent.
The moral of the story, and the moral of this series, is simply
to remind investors that it is more important to make the decisions
based on the actual merits of the individual companies they own
than it is on generalities. Not all common stocks are the same, and
most importantly, not all stocks will generate the same returns,
nor will their returns mirror the general stock market. We
believe this builds a strong case against worrying about what the
markets are going to do. Furthermore, predicting markets is
difficult to impossible, while predicting the prospects of a given
business is a much simpler and predictable task.
Disclaimer:
The opinions in this document are for informational and
educational purposes only and should not be construed as a
recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies
discussed may not continue and the companies may not achieve the
earnings growth as predicted. The information in this document is
believed to be accurate, but under no circumstances should a
person act upon the information contained within. We do not
recommend that anyone act upon any investment information without
first consulting an investment advisor as to the suitability of
such investments for his specific situation.