The Federal Reserve has delayed its plan to taper its bond-buying program, but it has by no means cancelled the plan – and that means investors continue to face uncertainty over what to do with dividend stocks.
Bank of America equity and quant strategist Savita Subramanian has some ideas. No, she isn't recommending a wholesale retreat, but rather a more selective approach to picking dividend stocks that can withstand what she calls a "normalizing interest rate environment."
Indeed, dividends have their place: "Demographics argue for continued demand, while supply is likely to stay tight as both interest rates and the S&P 500 payout ratio are trending well below average," she said in a note. "And equity income remains compelling, with one in five S&P companies offering a dividend yield higher than that of the 10-year Treasury bond."
The trick, she says, is to pick stocks that are less sensitive to rising interest rates: "Stocks that offer above-market yields but participate in a cyclical recovery may be most attractive to investors who now have lost money in both bonds and bond-like stocks," she said.
Ms. Subramanian calls them "half-growth/half-yield stocks," or stocks that have lower payout ratios and higher cash levels, and are therefore well-positioned to raise their dividends. Forget about utilities and telecom; many of them are technology, energy and industrial stocks.
To find them, she divided the Russell 1000 index of large-cap U.S. stocks into five groups, or quintiles, based on their dividend yields. She then focused on the second quintile: These stocks have smaller yields than the first quintile, but are still attractive. As well, their payout ratios are lower and their revenues are more diversified globally.
"Quintile 2 has offered the highest average return and the lowest downside risk over time," she said. "Additionally, many of these stocks are household names that even the most gun-shy equity investor may feel comfortable owning."
Unfortunately, there are 200 names from which to choose – ETF providers, are you reading? – but here is a sampling of 20 names from the group, from highest yielding to lowest.
Nucor Corp.
General Electric Co.
Chevron Corp.
McDonald's Corp.
Johnson & Johnson
Kellogg Company
H& R Block Inc.
PepsiCo Inc.
Corning Inc.
Campbell Soup Co.
Baxter International Inc.
Caterpillar Inc.
Kohl's Corp.
JPMorgan Chase & Co.
BlackRock Inc.
Tupperware Brands Corp.
The Mosaic Company
Target Corp.
Foot Locker Inc.
Fifth Third Bancorp
David Berman