5 Companies with Stocks that Pay More than Their Bonds

A great strategy for coping in today's rocky market is to buy high-yielding stocks.

For investors, 2008 was notable for many reasons, not least of which was the catastrophic decline in the prices of stocks and almost every other asset class that didn't have the word Treasury in its name. But the year also proved to be a watershed in market history, marking the first time since 1958 that dividend yields on U.S. stocks exceeded the interest rate on ten-year Treasury bonds. Before 1958, stocks had out-yielded Treasuries for as far back as records existed -- a period of at least 75 years.

It may be a while before the trend reverses. As stocks continue to sink and Treasury bonds continue to stage a remarkable rally, the yield disparity widens (as share prices fall, stock yields rise, assuming dividend rates remain constant; fixed-income yields, meanwhile, move in the opposite direction of bond prices). As of September 22, Standard & Poor’s 500-stock index yielded 2.38 %, and the ten-year Treasury yielded 1.72%, for a spread of 0.66 percentage point.

Investing in high-yielding stocks remains an excellent strategy for today’s rocky markets. It’s not especially hard to find stocks that pay more than Treasuries: 270 members of the S&P 500 currently yield more than the ten-year Treasury; of those, 105 yield at least twice what the ten-year pays.

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But we wanted to raise the bar, so we searched for stocks that pay more than the same company’s bonds (corporate bonds yield more than Treasuries because companies carry credit risk, while Uncle Sam, in theory, cannot default). Below, we identify five high-quality companies with stocks that pay more than their bonds (we compared the stocks with bonds maturing in roughly ten years).

All of the companies have staying power. But not only do we expect them to survive hard times, we think they’ll be able to maintain and increase their dividend payments. That makes holding their stock a big advantage over holding their bonds, which pay a fixed rate of interest. The stocks should also hold up better than the overall market during the current downturn and participate fully once the market emerges from its current funk. All share prices and related numbers are as of September 22. The stocks are listed in alphabetical order.

AT&T (symbol T)

Stock price: $27.75, yield, 6.2%.

Bond: 3.875% coupon, maturing August 2021 (Cusip no. 00206RAZ5), yield to maturity, 3.4%.

For juicy yields, it’s hard to top the payments from AT&T and its archrival, Verizon Communications (see below). Both companies continue to lose landline customers as people hang up on traditional phones and go exclusively wireless. But both have strong wireless businesses, which in AT&T’s case accounts for half of revenues, and they generate tremendous amounts of free cash flow (the cash profit left after the capital outlays needed to maintain the business) that serves as the basis for steady dividend payouts.

One uncertainty surrounding AT&T is its plan to acquire T-Mobile USA from Deutsche Telekom AG for $39 billion. The Justice Department has sued to block the deal on the ground that it would reduce competition and lead to higher prices for consumers. AT&T shares trade for 12 times 2011 earnings estimates of $2.38 per share.

Heinz (HNZ)

Stock price: $49.38, yield, 3.9%.

Bond: 3.125% coupon, maturing September 2021 (Cusip no. 423074AM5), yield to maturity, 2.9%.

The world, especially developing nations, craves ketchup and pickles, and Heinz plans to meet the demand. Heinz sees emerging markets accounting for more than 20% of its sales in the fiscal year that ends next April, and 30% by the year ending April 2016. That’s up from 16% in the year that ended last April.

The company aims to return 60% of its annual earnings to shareholders. It has boosted its dividend by nearly 80% since 2004, and it has paid out more than $3.5 billion to shareholders during that period. And its stock, at 15 times estimated earnings of $3.33 per share for the year that ends next April 30, looks cheap compared with the rest of the food sector, which on average trades at about 15 times forecasted earnings.

Johnson & Johnson (JNJ)

Stock price: $61.92 yield, 3.6%.

Bond: 2.95% coupon, maturing September 2020 (Cusip no. 478160AW4), yield to maturity, 1.9 %.

Investing in this well-diversified giant is almost like buying a health care mutual fund. J&J boasts a diversified revenue stream across drugs, medical devices and consumer products. Its pharmaceutical segment in particular is poised to profit from new products, such as treatments for hepatitis C, prostate cancer and HIV. In addition, the company recently acquired orthopedic medical-device company Synthes for $21.3 billion, a deal that will help J&J solidify its leading position in a fast-growing segment of the health care market.

J&J, one of only four non-financial U.S. companies with a triple-A bond rating, has raised its dividend 45 years in a row. The stock sells for 12 times estimated 2011 earnings of $4.97 per share, a fair price for a company of such high quality.

PepsiCo (PEP)

Stock price: $60.92, yield, 3.4%.

Bond: 3.0% coupon, maturing August 2021 (Cusip no. 713448BW7), yield to maturity, 2.6%.

Pepsi is benefiting from growing sales overseas -- especially in emerging markets, where it is expanding. Last February, for example, Pepsi acquired a majority interest in Wimm-Bill-Dann Foods, a Russian dairy company. The owner of such brands as Pepsi-Cola, Frito-Lay and Quaker Oats is also revamping its global beverage unit to boost profitability. Last year, the company bought its two largest North American bottlers, which should help it reduce costs and respond more nimbly to changing consumer tastes.

On a price-earnings basis, Pepsi shares are far cheaper than rival Coke’s. Pepsi trades at 14 times estimated 2011 earnings of $4.44 per share, compared with Coke’s P/E of 18.

Verizon Communications (VZ)

Stock price: $35.59, yield, 5.5%.

Bond: 4.6% coupon, maturing April 2021 (Cusip no. 92343VAX2), yield to maturity, 3.2%.

Like AT&T, Verizon is losing landline customers. Verizon’s cash cow is its 55% stake in Verizon Wireless, the nation’s biggest cell-phone company, with 94 million customers and service that covers of more than 95% of the U.S. population (Britain’s Vodafone owns the other 45%).

Verizon Wireless is benefiting from being able to offer Apple’s iPhone, which previously had been available only to AT&T customers. As customers upgrade from basic phones to iPhones, other smart phones and tablets, the business should prosper as demand for data services increases.

In a sign of how important Verizon Wireless is to its owners, the subsidiary plans to pay them a $10 billion dividend this January. Meanwhile, Verizon, the parent, is also expanding its FiOS service, a high-speed fiber-optic network for delivering TV, Internet and phone services. Verizon shares sell for 16 times estimated 2011 earnings of $2.23 per share.

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Jennifer Schonberger
Staff Writer, Kiplinger's Personal Finance