Ever since Operation Twist was announced, long term U.S.
treasury bonds have headed lower. The first part of the program ran
from September 2011 through June 2012, and the second part
initiated in July 2012 will run till December 2012. Uncertainty
over the European debt crisis has also made the U.S. treasury bonds
dearer thus driving down its yields.
However as bond yields decline, are investors ready to pay an
incremental premium for low beta and high dividend yielding stocks
? It would make sense that stock prices for high dividend stocks
would be bid up, which in turn would drive down the dividend yield
so that the spread between the bond yield and the dividend yield
would remain more or less the same. Note that the spread arises
because of the enhanced risk associated with the stocks as compared
to government treasury bonds, which are generally considered to be
risk free. Of course, stock price movements are subject to various
factors, and we don't intend to imply this is the only reason why
the prices of certain stocks have headed higher.
Mathematically too, it makes sense to have a higher valuation
for stocks during periods of low risk free rate, the discount rate
should be lower as well. Note that Trefis uses the discount rate
equal to a company's WACC (weighted average cost of capital) which
takes into account the cost of debt as well as the cost of equity
for a firm.
Under the Capital Asset Pricing Model, the cost of equity = the
risk free rate + beta*equity risk premium). Thus a decrease in bond
yields should pull down the cost of equity since risk free rate is
usually taken to be the treasury bonds. Similarly, given everything
else remains same, a company's cost of debt should also decline
with a decrease in treasury yields (so that the interest spread
remains more or less the same).
Mature companies within food & beverage (F&B) and
petroleum sector are good examples of companies with a low beta and
a moderate-to-high dividend yields We'll consider the performance
of certain stocks since June end (i.e. from the time Fed announced
its decision to extend the Operation Twist).
1) Exxon Mobil (
XOM
)
Dividend yield = 2.1%
Beta = 0.52
Performance since June end: Up 7-8%
2) Kraft Foods (
KFT
)
Dividend yield = 2.8%
Beta = 0.53
Performance since June end: Up ~10%
See full analysis for Kraft Foods
3) PepsiCo (
PEP
)
Dividend yield = 2.8%
Beta = 0.48
Performance since June end: Up 6-7%
4) Coca-Cola Co (
KO
)
Dividend yield = 2.6%
Beta = 0.53
Performance since June end: Flat. The stock climbed 10% in
between before retreating to the present level.
Dividend yield = 2.6%
5)
Wal-mart Stores
(
WMT
)
Dividend yield = 2.2%
Beta = 0.31
Performance since June end: Up 7-8%
Similarly, other stocks to consider could be Colgate-Palmolive
(CL),
H.J.Heinz
(HNZ) and
Chevron Corporation
(CVX).