Published on May 19th, 2018 by Bob Ciura
The S&P 500 Index is up just 1.6% year-to-date, through 5/18/18. When the market goes sideways, or worse yet—declines—stocks that pay dividends become even more valuable. Receiving quarterly dividend income helps boost returns, regardless of the direction of the broader stock market.
While high dividend yields are at times associated with a deteriorating business, there are some high-yielding stocks with strong brands and more than enough cash flow to sustain their dividends.
The following list encompasses a wide range of market sectors, such as telecom, consumer staples, and healthcare. It excludes REITs and MLPs, which are in the Sure Analysis Research database, but are separate asset classes, with unique risks and tax implications.
This article will discuss the top 5 stocks with 5%+ yields that we cover in the Sure Analysis Research database.
No. 5: Verizon Communications (VZ)
Dividend Yield: 5.0%
Verizon provides telecommunication services including cable, broadband, and wireless phone. Business conditions have become more challenged for Verizon over the past year. Wireless competition has intensified from lower-priced carriers such as T-Mobile (TMUS). Fortunately, incentives designed to retain customers—such as offering unlimited data—have worked well.
On 4/24/18, Verizon reported strong first-quarter earnings that beat on both the top and bottom lines. Revenue of $31.77 billion rose 6.6% from the same quarter a year ago, and beat expectations by $550 million. Earnings-per-share of $1.17 beat estimates by $0.06 per share.
Source: Earnings Presentation, page 8
Verizon Wireless revenue increased 4.9% last quarter, which more than offset a 1.6% decline in wireline revenue. Postpaid smartphone net adds were 220,000 for the quarter. For 2018, Verizon expects full-year revenue growth in the low-single digits. Adjusted earnings-per-share growth is expected to grow at a similar rate as revenue.
Verizon has positive long-term growth potential, because it has among the strongest networks in the wireless industry. The company spent $17.2 billion on capital investments in 2017 alone. New technologies will help Verizon retain its competitive advantages. Two emerging technologies that will fuel Verizon’s growth are 5G deployment and the Internet of Things.
According to Verizon’s 2017 annual report, 5G “will allow 10 to 100 times better throughput, 10 times longer battery life and 1,000 times larger data volumes than anything offered today”.
Source: Analyst Meeting Presentation, page 14
Verizon estimates the total market opportunity for 5G at $12.3 trillion, by 2035. Another catalyst from 5G deployment is that it will further enable Verizon’s Internet of Things, or IoT business. Verizon expects the number of IoT connections to increase to over 20 billion by 2020. Verizon’s IoT revenue increased over 10%+ in 2017, and rose by another 13% last quarter.
Verizon stock has a price-to-earnings ratio of 12. Over the past 10 years, the stock held an average price-to-earnings ratio of 14, which we believe is a reasonable estimate of fair value. As a result, a rising price-to-earnings ratio could add 3% per year to annual returns. Verizon’s high dividend yield will add to shareholder returns. Verizon had a 62% payout ratio in 2017, which indicates the dividend is secure.
To help further enhance its dividend coverage, Verizon is planning a massive cost-cutting program. The company is targeting $10 billion in cost reductions through 2021. The savings will be taken from operating and capital expenditures, as the company implements zero-based budgeting. It can use the cost savings to fund its dividend and pay down debt.
Through the combination of earnings growth, dividends, and an expanding price-to-earnings ratio, we project 13% annual returns for Verizon.
No. 4: Waddell & Reed Financial (WDR)
Dividend Yield: 5.1%
Waddell & Reed is an investment services provider that was founded in 1937. Today, it offers a wide range of financial advisory services. It has approximately $80 billion in assets under management (AUM). The past year has been difficult for Waddell & Reed. On 10/24/17 the company cut its dividend by 46%, due to falling AUM and poor fund performance.
Waddell & Reed has worked to turn things around, and it has had mixed results. On 5/1/18, the company reported first-quarter results that beat on revenue and earnings, but showed continued fund outflows. Revenue of $297.62 million increased 3.9% from the same quarter a year ago, and beat expectations by $10 million. Earnings-per-share of $0.56 also beat expectations, by $0.02 per share.
Investment management fees rose 2% year over year, while underwriting and distribution fees increased 7% year over year. However, AUM fell 1%, which indicates the company is still having some trouble retaining client funds. Waddell & Reed also announced that AUM dipped 1% in April, from the previous month. Declining AUM has been a challenge for Waddell & Reed since reaching over $120 billion in 2013.
Source: 2017 Annual Report, page 3
A dividend cut is never something investors want to see, but in this case the new payout level is much more sustainable. With earnings-per-share of $1.69 in 2017, Waddell & Reed’s forward dividend payout of $1.00 represents a payout ratio of 59%.
Waddell & Reed has an attractive 5.1% dividend yield, with the possibility of a return to earnings growth over the long-term. The strong performance of the stock markets remains a tailwind for financial services. In addition, the aging population of the U.S. is likely to result in greater demand for retirement planning and other financial services for the next several years. We believe Waddell & Reed can return to mid-single-digit earnings growth each year.
Waddell & Reed has a meaningful competitive advantage, which is its top position in retail investor services. The company primarily serves individual investors, a segment that has relatively light competition, which has allowed Waddell & Reed to secure a top position.
At the current share price, we believe Waddell & Reed stock is undervalued. We expect the company to report earnings-per-share of approximately $2.05 in 2018, which means the stock currently trades for a price-to-earnings ratio of 9.6. Our estimate of fair value is a price-to-earnings ratio of 12-13; a return to fair value would add 5% to annual returns.
Along with our forecast of 4% annual earnings growth, and a 5% dividend yield, Waddell & Reed stock could generate total returns of 15% per year.
No. 3: AT&T Inc. (T)
Dividend Yield: 6.3%
AT&T is on the list of Dividend Aristocrats, a select group of 53 stocks in the S&P 500 Index, with 25+ consecutive years of dividend increases.
You can download an Excel spreadsheet of all 53 (with metrics that matter) by clicking the link below:
AT&T is a giant telecommunications company. It has a market capitalization of $196 billion. It offers a variety of telecom services, including wireless and cable TV, as well as satellite TV through its subsidiary DirecTV.
AT&T’s first-quarter earnings report disappointed investors. For the 2018 first quarter, AT&T reported revenue of $38.04 billion and earnings-per-share of $0.85. Revenue and earnings-per-share missed analyst estimates by $1.27 billion and $0.02 per share, respectively.
Source: Earnings Presentation, page 3
The major catalyst for AT&T moving forward is the pending $85 billion acquisition of Time Warner (TWX), which has a number of strong media properties, including TBS, TNT, HBO, and the Warner Bros. movie studio. If the Time Warner acquisition receives approval, the combined company would have over 140 million mobile subscribers, and another 45 million video subscribers, worldwide. Time Warner is a very important piece of AT&T’s future growth plan.
Source: Earnings Presentation, page 7
However, in November the Department of Justice sued to block the proposed transaction, on antitrust grounds. The main portion of the trial recently concluded, with a final decision expected on 6/12/18.
AT&T has a highly secure dividend payout. Based on 2018 earnings guidance, the company is on pace for a dividend payout ratio of approximately 58%. The company ended the 2018 first quarter with $133.7 billion of long-term debt, which is a concern. To help mitigate the risk of rising interest rates, AT&T has a balanced maturity schedule. It also has a solidly investment-grade credit rating of BBB+ from Standard & Poor’s, which will help keep its cost of debt manageable when interest rates rise.
According to ValueLine estimates, AT&T is expected to generate adjusted earnings-per-share of $3.45 in 2018. The stock currently trades for a price-to-earnings ratio of just 9.3, compared with an average of 13.4 over the past 10 years. Therefore, we believe the stock is significantly undervalued, and an expanding price-to-earnings ratio could add 8% to shareholder returns each year.
Even assuming relatively low earnings growth of 2% per year, AT&T can still provide returns of 16%+ per year, through a rising valuation, earnings growth, and dividends. It has a long history of reliable dividend increases, and a high yield above 6%, which makes it a very attractive stock for income investors.
No. 2: Altria Group (MO)
Dividend Yield: 5.1%
Altria Group has a long track record of returning lots of cash to shareholders. It has increased its dividend 52 times in the past 49 years. Its impressive dividend history is due to its powerful brands. Altria is a consumer staples giant. It sells the Marlboro cigarette brand in the U.S., and a number of other brands, including Skoal, Copenhagen, and Ste. Michelle. Altria also has a 10% ownership stake in global beer giant Anheuser Busch Inbev.
Marlboro is the top cigarette brand in the U.S., and it is the flagship of Altria’s fleet.
Source: Investor Day Presentation, page 12
On 4/26/18, Altria released strong first-quarter earnings. Quarterly revenue of $4.67 billion increased 1.7%, and earnings-per-share of $0.95 rose 30% year-over-year. Revenue in Altria’s smoke-able products declined 0.8% for the quarter. Elsewhere, Ste. Michelle grew volume and revenue with wine shipment volume up 6.1%. In beer, equity earnings from its Anheuser Busch InBev investment were $225 million in the first quarter.
Going forward, Altria’s growth will be fueled by price increases and new products. Altria possesses tremendous pricing power, and it increases prices each year to offset declining smoking rates. In addition, Altria is innovating new products, such as its non-combustible product portfolio which includes e-vapor and e-cigarettes.
The company is awaiting regulatory approval from the Food & Drug Administration for its new reduced-risk product line called IQOS. Altria’s reduced-risk products heat tobacco rather than burn it, which Altria believes results in fewer harmful side effects.
Source: 2018 CAGNY Presentation, page 16
Even though shipment volumes of cigarettes are declining industry-wide, Altria still has positive earnings growth potential, thanks to price increases and new products. We forecast 7% annual earnings growth over the next five years.
Altria stock trades for a price-to-earnings ratio of 14.1. In the past 10 years, Altria stock traded for an average price-to-earnings ratio of 16.2, which is a reasonable estimate of fair value for Altria. If Altria stock returned to a price-to-earnings ratio of 16.2 by 2023, the expanding valuation would boost annual returns by approximately 3%. In addition to earnings growth and dividends, Altria stock has total return potential of 15% per year, which is a highly attractive rate of return.
No. 1: Owens & Minor (OMI)
Dividend Yield: 6.2%
Owens & Minor is a healthcare distribution, transportation, and data analytics company. It provides healthcare products, mainly pharmaceuticals, for hospitals and other medical centers. Owens & Minor distributes approximately 220,000 medical and surgical supplies to roughly 4,400 hospitals. Its other clients include group purchasing organizations, product manufacturers, the federal government, and at-home healthcare patients.
Source: April Investor Presentation, page 23
On 5/10/18, Owens & Minor announced first-quarter 2018 financial results. Earnings-per-share of $0.43 missed analyst expectations by $0.04 per share. Quarterly revenue of $2.37 billion increased 1.7% year over year, but also missed expectations, by $20 million. While both figures came in below analyst estimates, the results showed stabilization.
Revenue in the core Global Solutions Group, which represents 99% of total revenue, increased 2.3% for the quarter. Owens & Minor also showed signs that its turnaround remains on track.
Source: April Investor Presentation, page 14
Pharmaceutical distribution is still a challenged business, but we believe Owens & Minor has long-term growth potential. Healthcare has a long trajectory of growth up ahead, primarily due to demographic changes in the U.S., which is an aging population. In addition, Owens & Minor has conducted significant acquisitions to expand into new product and service categories.
For example, Owens & Minor acquired Byram Healthcare, a distributor of direct-to-patient medical supplies. This acquisition boosted Owens & Minor’s position in at-home healthcare. Byram added $118 million to Owens & Minor’s first-quarter revenue.
Also, on 5/1/18 Owens & Minor closed on its acquisition of the surgical and infection prevention business from Halyard Health. This deal expands Owens & Minor’s portfolio, to include new medical supplies like sterilization wraps, surgical drapes and gowns, facial protection, protective apparel, and medical exam gloves. These acquisitions will help the company enter new, high-growth product markets.
According to ValueLine analysts, Owens & Minor is expected to generate earnings-per-share of $2.00 in 2018. Based on this, the stock trades for a price-to-earnings ratio of just 8.4. We believe the stock deserves a price-to-earnings ratio of 14-15, since Owens & Minor is highly profitable and has strong customer relationships.
If the price-to-earnings ratio rises to our fair value estimate over the next five years, the expanding valuation would add 11% to annual returns. In addition, Owens & Minor has a dividend yield of 6.2%. The combination of a rising valuation, earnings growth, and dividends, could result in annual returns above 20% per year.