Stock Watch


6 Unexpected Dividend-Paying Stocks to Buy Now

Anne Kates Smith

Prices of popular dividend-paying stocks are being pushed higher and higher. It's time to look for dividends in less obvious places.



Investors can't buy dividend-paying stocks fast enough these days. And why not? Bond yields, especially those of Treasuries, are bumping along the floor, and the stock market, once again, is bouncing off the walls. What could be more satisfying than cashing dividend checks from a company that delivers them like clockwork for a plump 4% or 5% yield?

SEE ALSO: Great Funds for Growing Dividends

Trouble is, people have been thinking that way for a long time, and the prices of defensive, dividend-paying stocks have been bid up to extremes. Consumer staples companies -- those firms that make products we buy in good times and bad -- are expected to see earnings growth of 4% next year, less than the average of 5% for the companies in Standard & Poor's 500-stock index, according to S&P Capital IQ. Yet staples stocks command an average price-earnings ratio of 16 (based on estimated 2012 earnings), while the S&P 500 trades at 13 times estimated profits. Utilities and telecommunication firms are expected to earn less than they did in 2011, but their shares trade at lofty P/Es of 16 and 22, respectively, according to Thomson Reuters I/B/E/S. Normally (since 1995, anyway) utilities trade at a 26% discount to the market's P/E, telecom stocks trade right at the market's P/E, and the average P/E for staples stocks is slightly higher than the market's P/E.

Now might be a good time for investors to remind themselves that stock investing is a total-return game, says Andrew Slimmon, senior portfolio manager at Morgan Stanley Smith Barney. Although the bulk of the piddling returns from stocks over the past ten years have come from dividends, it could be that over the next decade, stocks of companies whose earnings are growing at a faster clip will perform better than stocks with the biggest yields. "The market is perverse," says Slimmon. "When investors clamor for dividends, it is not the time to be chasing them."

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We don't think that existing shareholders -- especially those with a long-term view and those in taxable accounts who have a low basis in their shares -- should dump dividend overachievers just because they're expensive. And for investors who seek only income, the stocks are a reasonable substitute for bonds.

But investors shopping now for dividends will do best by venturing beyond the obvious -- and over-shopped -- candidates. "It's not just consumer staples, telecom and utilities stocks offering above-average dividend yields," says analyst Todd Rosenbluth, of S&P Capital IQ. "We've seen tech companies initiate and raise dividends, as well as energy and industrial companies." Companies that recently began paying dividends or those that pay modest but growing dividends will likewise prove to be better buys now.

Don't worry too much about the possibility of paying higher taxes on dividends. It's almost certain you will. The 15% tax rate on dividends expires this year, and it will likely be raised -- perhaps to 20%, or perhaps to ordinary income rates (possibly to more than 40% for high-income taxpayers). "Owning dividend-paying companies makes sense regardless of taxation," says Thomas Huber, manager of T. Rowe Price Dividend Growth Fund. "They have been proven over many business cycles and many tax environments to do well." Huber says that the biggest threat to the stocks would be rising interest rates, which would make bonds more competitive.

We found plenty of reasonably priced stocks that deliver above-average yields (the S&P 500 yields 2.3%). These companies have solid finances with enough cash to finance and increase their dividends. In particular, we looked for companies with a low payout ratio (the percentage of a company's earnings paid out in dividends). A payout ratio of less than 50% indicates that a company has flexibility to boost the dividend. Below, we describe six standouts.

Aflac (symbol AFL)

This life, health and long-term-care insurance giant is known in the U.S. for its popular ads starring the Aflac duck. But the Columbus, Ga., company has a much larger footprint in Japan, which accounts for 75% of its revenues. Japanese customers can purchase policies at bank and post office branches, among other places, and are remarkably loyal, sticking around, on average, for 20 years. Japan's aging population makes the country a favorable market for the sale of policies to supplement state-provided health care. And the underserved U.S. market provides plenty of opportunity, too. Since the financial crisis, Aflac has toned down risk in its investment portfolio. At $46.09, the stock sells at a bargain price of 7 times the average of analysts' estimated 2012 earnings of $6.53 per share and yields 2.9%. Analyst Steven Schwartz, of Raymond James & Associates, has a 12-month price target of $57 for Aflac's stock (share prices and related data are through August 20).

Applied Materials (AMAT)

If you want to see how to manage the swings of a highly cyclical industry, check out Applied Materials. The Santa Clara, Cal., company makes the tools and equipment that chip makers use to fabricate semiconductors. It's as close to a one-stop shop as you can get, says Morningstar. The company has some 22,000 tools installed in manufacturing facilities, and its engineers are in nearly every chip-making enterprise around the world. Things looked up earlier this year as chip makers upgraded to the newest technologies. But equipment orders slowed in the second half of 2011 as manufacturers fretted about the economy, and orders may remain stalled until they rebound next year. Analysts expect earnings to fall 45%, to 72 cents per share, in the fiscal year that ends this October, then climb to 82 cents a share in the October 2013 fiscal year. But a solid balance sheet gives Applied Materials the wherewithal to withstand such swings, plus maintain an annual budget of $1 billion for research and development, make acquisitions to increase the company's market share (such as the recent $4.2 billion purchase of Varian Semiconductor), and fund a dividend. At $11.96, the stock yields 3.2%.

Chevron (CVX)

The world's fourth-largest oil company (based on reserves) mans oil and natural gas operations from places as far flung as Kurdistan and as close to home as Pennsylvania. Although Chevron is downsizing its refining operations in the U.S., it continues to maintain a large refining business in Asia, where it should benefit from growing demand in developing markets. Chevron has the financial muscle to fund mega-projects without having to borrow money, pursue acquisitions and hand cash back to shareholders via dividends and stock buybacks. The company, which has paid dividends since 1912, bumped up the quarterly payout by 11% in April. At $112.51, the stock trades at just 9 times estimated 2012 earnings of $12.71 a share -- a bargain for a premier oil company, says portfolio manager Slimmon, especially given Chevron's current yield of 3.2%.

General Electric (GE)

The ginormous conglomerate, which makes everything from refrigerators to railroad locomotives, is enjoying a bit of an industrial renaissance. Analysts expect double-digit earnings growth this year and next, despite a choppy global economy. One-fifth of GE's revenues come from Europe, and the dire situation there will likely cut into GE's lending, leasing and health care businesses. Offsetting that is a strong performance from GE's infrastructure business, as well as its aviation and transportation divisions. Meanwhile, the Fairfield, Conn., company is shrinking the size of GE Capital, the company's finance arm, even as it continues to recover from the financial crisis. The stock, at $20.93, yields 3.2%, and there's likely to be a dividend boost later this year, says S&P Capital IQ analyst Richard Tortoriello.

Kohl's (KSS)

Customers of this retailer are looking for brand-name goods at bargain prices -- and investors might be picking up a future dividend star on the cheap as well. Despite today's reluctant consumers, Kohl's has been able to open new stores and remodel others while reducing debt, buying back shares and paying dividends. Kohl's initiated dividends only last year, and the stock's yield -- currently 2.5% at a price of $51.92 -- barely bests the S&P 500's yield. But the prospects for growth are good, says Price's Huber, and catching a rising dividend star at the outset can pay off. "When managers decide their company can finally generate enough capital to return dollars to shareholders, the change in philosophy can be an important turning point," he says.

Wells Fargo (WFC)

Financial firms have traditionally paid big dividends, but only a fraction of these companies are paying out as much as they did before the financial crisis. Many banks must receive permission from regulators before reinstating or raising dividends. And while a growing number of financial companies are getting a green light from the feds, Wells Fargo, the nation's largest mortgage lender and a large holding for Warren Buffett's Berkshire Hathaway, is among the few with the capacity to commit to a more generous dividend policy, says Huber. The lender, seeing both increased loan volume and improved credit quality, nearly doubled its quarterly dividend in March, from 12 cents a share to 22 cents. The stock, at $34.07, sells at 10 times estimated 2012 earnings of $3.32 a share and yields 2.6%.

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