Screening for Dividend Stocks (Sam Stovall in Forbes)

5 Cheap Stocks With Great Yields

AN INTERVIEW WITHSam Stovall, CFP

Managing Director, U.S. Equity Strategy, S&P Capital IQ  WH13515582

Sam Stovall: What I’m telling investors today is to remember a year ago, when Fed Chairman Bernanke first uttered the “tapering” word and it ended up spooking investors to the point where the S&P 500 declined almost 6%. But what we found was that high-dividend-paying stocks ended up declining almost a full percentage point more.

And since then, while the low-dividend payers have seen an increase of about 16% in price, the higher-dividend payers have seen an increase of only about half that. So, I think investors should think back to a year ago and say to themselves, “Was that a preview of coming attractions?” Or, in other words, don’t forget how high-yielding issues reacted to the threat of rising rates. I think that today, the bond market is going through a counter-trend rally — meaning that the yield went up to a shade above 3% from 1.7% in April of that year, 2013.

But here we are, almost five full months into 2014, and the yield on a ten-year note is down to about 2.5%. I don’t think that the reason for that is because the economy is getting weaker. I think it’s a counter-trend rally. I think that maybe some global concerns are causing global bond investors to gravitate toward the U.S. bond market. But I don’t think it’s a reflection of concern about our own economic health.

As we’ve seen in recent economic data, like retail sales, industrial production, most recent housing data, durable-goods orders, this economy does look, now that the bad weather is behind it, as if we could end up with pretty impressive results in the quarters ahead.

Wally Forbes: That sounds encouraging.

Stovall: Absolutely. What I’m telling investors is to remember also that a good one quarter of all stocks in the S&P 500 that yield 2.5% or more are still trading below where they were a year ago. So, even though the market itself is up 25%, many stocks that yield 2.5% or more are still underwater. So, remember what could happen should interest rates start to rise again in the near future.

Forbes: You think that they are particularly vulnerable?

Stovall: I would say that they could be vulnerable. I know that a lot of people are starving for income, but I believe they should not yield to temptation. Don’t buy a stock just based on a relatively attractive-looking yield.

Rather, they should focus on a few things. Take a look at a stock that has a nice dividend yield, 2.5% or more. But also take a look at what is its beta. What’s the volatility versus the overall market? You want to make sure that you go to the amusement park, but you’d rather be on the merry-go-round than the rollercoaster. Make sure that the beta is one or less, meaning that it moves with the market or its movements tend to be more subdued than the market.

Also, don’t, in a sense, give other investors reason to dump the stocks that you’re thinking about buying. By that, I mean don’t buy an overly expensive issue right now. If the S&P 500 has a P/E of 15 for the coming 12 months, look for those stocks that also have a P/E ratio of 15 or less.

Forbes: Do you have some specific stocks that you think fit this formula?

Stovall: Absolutely. By doing a screen, looking for stocks with a dividend yield of 2.5% or better with a beta of one or less, a P/E of 15 or less, that also happen to have buy recommendations by S&P Capital IQ equity analysts. I have five sectors, so I can give you one from each sector.

Forbes: Great.

Stovall: All right. First is Target TGT +0.69% (NYSE: TGT). It’s in the consumer discretionary sector. It has a beta of 0.9. It has a P/E on forward-12-month earnings of 14. It has a nice dividend yield of 3%. And also, the company has a track record of raising their earnings and dividends that is above average. It has an A letter grade in terms of quality rank. We think that that it will continue to offer a nice yield and could end up having less volatility than other retailers in its category.

Forbes: Wasn’t it Target that had the problem with the credit cards?

Stovall: Yes, it was. But I think that all of that is behind it and is certainly reflected in its share price.

In the energy sector, you could say, “Gee, this seems to be a perennial favorite”:Chevron CVX -0.16% (NYSE:CVX). It also has a beta of 0.9 — so a shade below the market as a whole. It is trading at a P/E of only nine times the forward-year earnings. It has a dividend yield of 3.4%. And it also has a quality-rank letter grade that’s an A. And as a sidebar, I like to tell investors who are looking at income-oriented stocks, treat an income payer the way you would a rental property. You’re not going to value that rental property every day, every week, or every month.

What you’re going to focus on is, “Am I going to get my rent?” And, so, if you are buying a stock because you want X dollars of rent per month, per quarter, whatever, then that’s what your primary focus should be. Don’t worry about the gyrations of the stock price. Just make sure that that rent payment is secure and the share price will take care of itself.

Forbes: So this is buying the renter?

Stovall: Yes, I guess so, or at least thinking like a landlord when dealing with income-oriented stocks. That’s how I would look at it.

Another company in the financial services area is ACE Limited (NYSE: ACE). It’s a specialty insurer. This company has a dividend yield of 2.5% — so right on the margin in terms of making the screen. It also has a beta of one, equal to the market — so also pretty much on the cusp. It has a P/E of 11 and has a favorable investment outlook by S&P analysts.

Forbes: And you say it’s a specialty insurer. What area of specialty?

Stovall: It provides commercial insurance and reinsurance for a diverse group of international clients. It’s a large-cap, value stock.

Also, we have one in telecom service. It’s a pretty high yielder — 5.7% is whatCenturyLink CTL 0% (NYSE: CTL) yields. Its beta is half of that of the market at 0.5. And its P/E is 13. At least you’ll get paid nearly 6% while you wait.

Then, lastly, in utilities, PPL Corporation (NYSE:PPL). This has the lowest beta of the entire group at 0.3. It has a P/E of 13. And it’s offering a nice yield of 4.4%.

Forbes: Wow.

Stovall: And this, too, has a buy recommendation. I feel like the reason why I want to have a buy recommendation by our analysts is that they would not knowingly put a buy recommendation on a stock if they felt that the dividend was going to be cut.

Forbes: What does PPL do?

Stovall: Specifically, PPL Corp is a holding company for electric utilities in Pennsylvania and Kentucky and, believe it or not, also owns utilities in the United Kingdom.

These are all large-cap companies — pretty much so, anyway. And I think that if investors are a little bit nervous about the market, there’s an old saying that, “When the seas get rough, sailors prefer a larger boat.”

Forbes: And this is a larger boat.

Stovall: That’s why large-cap issues tend to do a little bit better than smaller-cap issues, primarily because of supply chains being a little stronger, their own financial backings being a little healthier, et cetera.

Forbes: Thank you very much, Sam, for taking the time to share your always-stimulating ideas with us.

Stovall: It’s my pleasure, Wally.