When It Comes to Dividends, Focus on the Fundamentals

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While the stock market has bounced back strong this year following a difficult 2011, investors still aren't exactly pouring into stocks. In fact, many continue to flat-out avoid equities.

Except, that is, for at least one part of the market: dividend stocks. In a recent article for The Wall Street Journal, Jason Zweig noted that so far this year, investors have put a net of $9 billion into mutual funds and exchange-traded funds that focus on US stocks that pay stable, high, or rising dividends (Zweig cited fund flow data from EPFR Global). Over the same period, investors had removed a net of $7.3 billion from all other US stock funds.

Zweig cautioned investors, saying it seems that many may be rushing into dividend stocks for the wrong reasons -- either because, with bond yields so low, they're looking for an easy way to replace income in their portfolios, or simply because dividend stocks did well last year. The latter are playing the ever-dangerous game of performance-chasing; the former may be ignoring the fact that, unlike with bonds, you don't necessarily get your capital back when you buy a dividend stock. (And that's more likely to happen if you buy them when they've gotten too popular and overvalued.)

I think Zweig is wise to express caution. Rushing blindly into high-dividend stocks because they did well last year is not good investing, nor is buying them simply because they have a high yield -- sometimes, the dividend yield will be high because the price of the stock is very low, and low for good reason (i.e., the firm is a dog and its shares are going nowhere). And, after all, what's the point of getting a high dividend payment if the stock costs you money by performing poorly?

So, if you're going to look for income through stock dividends, you need to make sure that -- as with any stock you buy -- the stock's fundamentals are strong and the company's balance sheet is solid. With that in mind, I recently used my Guru Strategies (each of which is based on the approach of the different investing great) to find some stocks that not only have high dividend yields, but also have attractively priced shares and solid financials. I found a number that fit the bill, and are good candidates not just for steady income but for capital appreciation as well. Here are some of the best of the bunch.

Total S.A. ( TOT ): This Paris-based oil and gas giant has operations in more than 130 countries. The firm has a $114 billion market cap has taken in about twice that in sales over the past 12 months.

Total gets approval from my James O'Shaughnessy-based model. When looking for value plays, O'Shaughnessy targeted large firms with strong cash flows and high dividend yields. Total certainly has the size, plus it is generating $11.06 in cash flow per share (more than eight times the market mean), and it has a dividend yield of 6.3%.

My Peter Lynch-inspired model also likes Total. While Lynch liked companies with high earnings growth, he would invest in slower-growing firms if their valuation and dividend yield were good. Total has been growing earnings per share at a rate of only about 1.5% over the long haul (I use an average of the three-, four-, and five-year EPS figures to determine a long-term rate), but it trades for just 6.7 times earnings and has that 6.3% yield. So when we divide that P/E by the sum of its growth rate and yield, we get a yield-adjusted P/E-to-growth ratio (the P/E/G is a valuation metric Lynch pioneered) -- of just 0.85, which comes in under this model's 1.0 upper limit.

AstraZeneca PLC ( AZN ): Based in London, AstraZeneca is one of the world's largest drugmakers. The $57-billion-market-cap firm is active in more than 100 countries, and makes a variety of well-known medications.

AstraZeneca is another favorite of my Lynch and O'Shaughnessy models, in part because of its stellar 6.3% dividend yield. The Lynch-based approach likes its solid 17.3% long-term growth rate and sparkling 0.26 yield-adjusted P/E/G, as well as its reasonable 40% debt/equity ratio. The O'Shaughnessy-based model likes the firm's size, $9.83 in cash flow per share, and that hefty yield.

Paychex, Inc. ( PAYX ): New York State-based Paychex offers services that include payroll processing, retirement services, insurance, and human resources, and has more than 100 offices across the U.S. The $11-billion-market cap firm gets high marks from the strategy I base on the approach of the great Warren Buffett.

My Buffett-based model 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). Paychex delivers on all fronts. Its EPS have increased in all but two years of the past decade; it has no long-term debt; and its 10-year average ROE is an impressive 31.8%.

Public Service Enterprise Group Inc. ( PEG ): New Jersey-based PSEG is an integrated power generation company with assets in New York, New Jersey, Connecticut, and Pennsylvania. It is involved in the nuclear, coal, gas, and oil arenas. About half of the energy it produces is nuclear, which may be part of why the stock is a bargain -- the tragedy in Japan had a guilt-by-association impact on many nuclear power firms.

PSEG gets strong interest from my Lynch model. The firm has been growing EPS at a moderate 10.9% rate over the long haul, and in combination with its 10.7 P/E and 4.8% dividend yield, that makes for a 0.68 yield-adjusted PEG, a good sign. It also has a debt/equity ratio of about 80% -- which, for a utility, is very good (its industry average is over 130%).

Southern Copper Corporation ( SCCO ): In addition to copper, this Arizona-based firm also produces molybdenum, zinc, lead, coal, and silver. All of its mining facilities are located in Peru and Mexico; the firm's exploration activities take place in those two countries, as well as Chile.

Southern Copper ($26 billion market cap) gets high marks from my Lynch-based strategy. The firm has grown EPS at an 8.6% pace over the long haul -- not exactly gangbusters, but when you consider its dividend yield of 6.6% and its 11.4 P/E ratio, the stock is trading at a very reasonable yield-adjusted PEG of 0.75. Southern also has a debt/equity ratio of 68.4%. That's good enough to come in under this models 80% threshold, another good sign.

I'm long PAYX, TOT, AZN, and SCCO.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AZN , PAYX , PEG , SCCO , TOT

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