Opportunities In Dividend Land

With “On Sale” tags affixed to many equities right now (though the discounts aren't as steep as they were several days ago), how do investors find the best dividend bargains? Better yet, how should people approach equity income in the first place?

“In order to have a safety cushion, I’d want the payout ratio to be less than 70% so that if the company falls on hard times and their earnings fall by 30%, they still will cover the dividend,” says Sam Stovall, chief investment strategist at investment-research firm CFRA.

He notes that traditional dividend-paying defensive sectors—e.g., consumer staples, communication services and utilities—were risky even before the crisis because they were trading at high absolute and relative price-to-earnings multiples. That said, they’ve held up the best during the downturn. Which means, on a relative basis, their respective current p/e ratios are still trading at a premium to their average p/e ratios over the past 20 years.

Based on current and 20-year average relative p/e ratios, Stovall explains, the biggest discounts are found in the financial, health-care and industrial sectors that have suffered the largest price declines during the past month.

“Those sectors likely to bounce the highest once we get some sort of a recovery will be those that took it on the chin the most,” he says.

Regarding individual names that could be good dividend-oriented investments right now, Stovall ran companies through CFRA’s qualitative STARS system and came up with 20 candidates that, as of last Friday, fit the bill based on their “strong buy” or “buy” ratings, quality rankings in the “A” range, and dividend yields of at least 3% and payout ratios equal to or less than 70%.

That list includes CVS Health, General Mills, Pinnacle West Capital, Tyson Foods and DTE Energy. Other names he mentioned include Ameriprise Financial, State Street and JPMorgan among financials, as well as industrial names such as General Dynamics, Lockheed Martin, Raytheon and United Technologies.

Dividend Cuts

The sudden clampdown on the U.S.—and global—economy caused by COVID-19 has hammered many businesses and their cash flows. In response, a host of companies including Ford Motor Co., Delta Air Lines, Alaska Air Group, Freeport-McMoRan, DCP Midstream Partners, Boeing, Darden Restaurants, Macy’s, Marriott International and Coach parent Tapestry this month announced they’ve suspended or cut their dividends, among other measures to preserve cash. 

David Trainer, CEO of investment-research firm New Constructs LLC, sees more dividend cuts or suspensions coming. “Certainly, companies with limited cash flow for paying dividends could be in some trouble,” he says, noting the energy sector is a prime candidate in this regard.