The S&P 500 yields less than 2%, but that says nothing about the yield of each individual component.
Within the S&P 500, higher yield can be found. The key, though, is to find higher yield (which I define as 5% or higher) that is sustainable and will lead to wealth accumulation over time.
Tread carefully; inclusion in the S&P 500 doesn’t automatically confer an investment grade.
For instance, I want nothing to do with the highest-yield S&P 500 stocks: Windstream (NYSE: WIN) (12%), Frontier Communications (NYSE: FTR) (8.5%), or CenturyLink (NYSE: CTL) (7%). These S&P 500 stocks are high yield not because of superior cash flow, they’re high yield because of a falling share price and a dying business model.
Better income opportunities reside in three stocks whose yields are slightly lower than the aforementioned trio, but whose cash flows are sustainable and much more likely to increase over time.
I’m referring to AT&T (NYSE: T), Altria (NYSE: MO), and Diamond Offshore Drilling (NYSE: DO). All three of these S&P 500 stocks yield above 5%, and all three are much better positioned to maintain their high yield.
I like AT&T because it and Verizon (NYSE: VZ) rule the cellular communications space. I view AT&T as the better value, though. It yields 5.3% compared to Verizon’s 4.3%. AT&T also trades at a forward P/E multiple of 13.1 compared to Verizon’s forward P/E multiple of 13.9.
AT&T continues to chug along, with annual revenue and earnings growth in the 5% – 7% range. Growth is unspectacular, to be sure, but the business model generates ample cash to keep the dividend payout moving higher year after year – which it has done for the past 30 years.
High yield combined with dividend growth are a potent wealth-creating combination that’s difficult to overlook, which is why I’m not overlooking AT&T.
High yield and dividend growth is also why I’m not overlooking Altria, the maker of Marlboro cigarettes and Skoal smokeless tobacco.
Altria’s shares yield 5%, and they always seems to yield 5%. Altria consistently hikes its dividend payout 8% – 10% year after year, which it has done for the past 45 years. And as the payout goes, so goes Altria’s share price.
A rising dividend payout combined with a rising share price translates to a long-term average annual total return of 20% – the best in the S&P 500.
Altria hit for the average again in 2013. I expect more 20% annual returns are forthcoming. Each year the company rings more profit out of each cigarette sold. This remarkable ability to do more with less keeps the needle moving and makes Altria a difficult company to bet against.
I won’t bet against Altria, and I will bet on Diamond Offshore Drilling turning its fortunes around in 2014. The company has been hit by a plague of maintenance problems on some of its larger drilling rigs over the past year.
In addition, one of Diamond’s customers, the Brazilian energy company OGX, filed for bankruptcy. Diamond had two large rigs working for OGX. The company expects write-offs related to OGX’s bankruptcy to approach $60 million.
When OGX’s financial problems surfaced this past summer, investors began selling Diamond shares, which are down nearly 15% in the past six months.
The good news is the depressed share price presents a buying opportunity. Diamond’s problems appear to be in the past. In a recent analysts meeting, management stated maintenance costs would return to historical norms and that the rigs associated with OGX are being sent for work in the Pacific.
I’m further encouraged by management’s commitment to the annual $3.50-per-share dividend, which generates a generous 6.2% yield on Diamond’s depressed share price.
Despite recent problems, Diamond is still a well-run, conservatively managed company. It maintains low debt levels at 0.33% of capitalization, and a high cash level at $1.2 billion. It’s also a company run by the Tisch family, which has an exemplary record of creating shareholder value.
I expect Diamond shareholders will finally see value created in 2014.
(Disclosure: Stephen Mauzy owns shares of Diamond Offshore Drilling)
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