U.S. Blue Chips With Fat Dividends Offer Value
After last week’s market selloff and rebound, stocks of companies such as GE, JPMorgan Chase, Merck, and BlackRock offer value plus income.
The worst may be over.
U.S. stocks roared higher for much of last week, reversing Monday’s gut-wrenching losses and leaving major indexes with modest gains at week’s end. Investors concluded that a still-healthy U.S. economy is unlikely to be derailed by a slowdown in China, and took comfort in Thursday’s news that second-quarter gross domestic product grew by a revised 3.7%. Wall Street also cheered indications that the Federal Reserve might shelve a potential interest-rate hike in September. U.S. economic growth could average close to 3% in the second half of this year, hardly gloomy conditions associated with a bear market.
The Street quickly came around to the view of bullish strategists such as Goldman Sachs’ David Kostin, who observed in a client note that only 2% of sales generated by companies in the Standard & Poor’s 500 index come from China, and less than 1% of U.S. exports go to China. “We expect the U.S. economy will avoid contagion and continue to expand,” he wrote.
Kostin projects the S&P 500 will return to 2100 by year end, which implies a 5% gain from Friday’s close of 1989.
“The stock market responded sharply and excessively to fears of a slowdown in China,” says Charles Lieberman, chief investment officer of Advisors Capital Management, a New Jersey investment firm. “The U.S. doesn’t export a lot to China. The countries that are vulnerable are commodity producers like Australia and Canada.”
Jeremy Grantham, chief investment strategist at GMO in Boston, says the U.S. economy and stock market “flag very few of the real bubble indicators. The economy doesn’t look like it’s on the cusp of recession. Housing is picking up, and hiring is good.”
Lieberman and many other investors saw a buying opportunity after the market plunge on Monday, when the Dow industrials fell 588 points, or 3.5%, its largest daily percentage decline since 2011. One of the most attractive parts of the stock market could be dividend-paying blue-chip stocks, many of which yield 3% or more. These include General Electric (ticker: GE), JPMorgan Chase (JPM), Merck (MRK), BlackRock (BLK), DuPont (DD), and Procter & Gamble (PG).
Dividend payers in the S&P 500 have lagged behind the overall market this year, as investors have favored low or no-yielding growth stocks such as Amazon.com (AMZN), Facebook (FB), Netflix (NFLX), Google (GOOGL), Valeant Pharmaceuticals International (VRX), and Allergan (AGN). Investors can now put together portfolios with bond-like yields and growth potential.
SOME WOULD ARGUE that the market recovery has been too neat, and that it is hewing too closely to the script put forth by many strategists, which called for a quick and brisk bounce-back. But there’s a reason for the snapback: While stocks, as measured by the S&P 500, aren’t cheap by historical standards at a current 16 times forward earnings, they aren’t expensive, either. The earnings yield, the inverse of the price/earnings ratio, is 6%, or more than 2.5 times the yield on the 10-year Treasury bond. As Barron’s noted last week (“A Late-Summer Swoon, Not a Crash,” Aug. 24), the S&P 500 dividend yield of 2.2% matches that of the 10-year Treasury.
The Dow Jones Industrial Average gained 1% in last week’s recovery, to 16,643, almost 1,000 points above its closing low on Tuesday of 15,666. The big drop of 588 points came on Monday, but that was more than offset by a 618-point rise on Wednesday. The S&P 500 index finished on the week at 1989, up 1% after bottoming at 1868 on Tuesday. Both averages are still in the red for the year, however, with the Dow industrials off 7% and the S&P down 3%.
About a third of the sales of S&P 500 companies are generated outside the U.S., but that figure probably overstates the impact of overseas economies. Energy companies, for instance, get almost half their sales outside of the U.S., but much of their production is outside the U.S., too. As the table nearby illustrates, energy has been the worst sector in the S&P 500 this year, with an 18% decline. Investors have done better with U.S.-focused sectors such as financials and health care.
WHERE SHOULD INVESTORS LOOK now? Some managers like above-average dividend payers, which have lagged behind high-growth stocks this year.
“We emphasize large-cap companies with tremendous financial strength that have grown their dividends over time,” says Hank Smith, chief investment officer at Haverford Trust in Radnor, Pa. “The market selloff and the concurrent decline in bond yields highlight an opportunity. Investors can get better income from stocks than bonds, and also get growth in income with stocks, which you don’t get in fixed income.”
But he admits there’s “no free lunch” with stocks: “You have to tolerate volatility.”
Smith cites a group of attractive companies, including McDonald’s (MCD), DuPont, GE, JPMorgan, Wells Fargo (WFC), Coca-Cola (KO), P&G, ExxonMobil (XOM), and Chevron (CVX).
GE, at about $25, isn’t cheap at 19 times estimated 2015 earnings. But profits could grow at a double-digit rate in coming years, as it aims to create what it calls a “focused infrastructure and technology company,” with 90% of earnings coming from industrial business by 2018. GE is divesting the bulk of its financial-services operations.
While the Street remains skeptical of GE, the company aims to return $90 billion of cash to investors from 2015 through 2018. With reduced financial-services earnings, GE plans to maintain the current dividend of 92 cents a share through 2016 and increase it thereafter. The stock now yields 3.7%.
McDonald’s, at $97, looks fully priced at 20 times estimated 2015 earnings, but there is considerable restructuring potential at the fast-food giant, given its large real estate holdings. Activists are circling. McDonald’s shares, now yielding 3.5%, could get a nice lift if the company ever gets a management team like Brazil’s 3G Capital, which delivered at rival Burger King with a weaker hand. Burger King is now part of Restaurant Brands International (QSR).
In the drug sector, Merck’s shares may not reflect the big potential for its immuno-oncology drug, Keytruda, which was highlighted in last week’s cover story (“Race for the Cure”). Merck, at $55, trades for 15 times projected 2015 earnings, a discount to its peers, and yields 3.3%. Bernstein analyst Tim Anderson carries an Outperform rating on the stock with a $70 target, having called it “out of favor with a high-value pipeline.” Barron’s wrote a positive piece on Merck this past spring, when the shares were at $58 (“Merck Builds a Pipeline to Profits,” June 22).
Novartis, at $98, yields 2.7%—less than Merck. It has a higher price/earnings multiple, but that is offset by one of the best projected growth rates among major drug companies through 2020.
JPMorgan may be the best-run of the major banks, and generates earnings from more sources than most peers. Yet, at $64, it trades at a modest valuation of less than 11 times future earnings, and yields 2.7%.
BlackRock, the world’s largest asset manager with almost $5 trillion under management, also has best-in-class management led by CEO Larry Fink. At $314, shares trade for 16 times estimated 2015 earnings and yield 2.8%. BlackRock returns about 75% of its profits to shareholders in dividends and buybacks. At a time when the asset-management industry has fallen from favor, as investors embrace passive strategies and exchange-traded funds over actively managed mutual funds, BlackRock is in a strong position as the No. 1 manager of ETFs with its iShares franchise.
Warren Buffett usually doesn’t make investment mistakes, but International Business Machines (IBM) so far has been a loser. The CEO of Berkshire Hathaway (BRKA) paid an average of about $160 for a $12 billion stake in IBM, mostly acquired in 2012, and Big Blue’s shares now trade for about $148. Buffett remains a believer, and IBM’s valuation is one of the lowest among major tech companies at 9.4 times estimated 2015 profit. The stock yields 3.5%. “All it would take for the stock to go up significantly would be for IBM’s quarterly earnings to beat on the top and bottom line, and for management to offer some positive comments,” Smith says.
THE STREET’S ENTHUSIASM for Intel (INTC) has waned as optimism about its inroads into chips for mobile devices has been replaced by concerns about its exposure to the eroding PC market. With Intel down more than 20% this year, to $27, it looks appealing, at less than 13 times projected 2015 earnings. It yields 3.5%.
P&G’s many stumbles, including missteps that led to the sale of its beauty business to Coty (COTY) this summer, have depressed its shares, which are off more than 20% this year, to $71. With the selloff, its shares yield 3.7%. P&G’s valuation is about average for the sector, but it is arguably one of the most undermanaged of the major consumer companies and is ripe for improvement.
After P&G offered disappointing guidance for the fiscal year ending in June 2016 when it reported its June quarterly results last month, Bernstein analyst Ali Dibadj said, “We remain interested in the stock given the potential at P&G, but we continue to be frustrated. Investor patience is running low. Perhaps the time for more drastic measures at P&G is here.”
He has an Outperform rating and a $87 price target.
Reflecting weakness in most of its major markets, DuPont has fared poorly this year, with its shares down 26%, to $52, reflecting the spinoff of Chemours (CC), its titanium-dioxide business, in July. DuPont trades for 16 times projected 2015 profits and yields 2.9%. Activist investor Nelson Peltz’s Trian Partners lost its attempt to gain board seats but remains a large holder and a likely influence on the company.
Ford Motor (F) delivered better-than-expected second-quarter profit last month and offered strong second-half guidance. The Street wasn’t impressed, however, and its shares are languishing, as investors worry about a potential weakening in the hot U.S. auto market and a slowdown in China. As a result, at about $14, Ford trades for just eight times projected 2015 earnings and yields 4.4%.
Even with the market recovery, there are plenty of appealing dividend-rich companies with underappreciated prospects.
