Tuesday, September 07, 2010

Dividend Oriented Portfolio Poised to Outperform?

I've recently written about the relatively high dividend yields available from some of the major S&P 500 companies in comparison to the terrible yields in things like US government bonds (10 years at 2.5%) and municipal bonds.

In my opinion, the bull market in bonds is due to come sliding - possibly crashing - down, just as other inflated investments have in the recent past, eg NASDAQ, peak years 2000-2001, US housing market years 2006-2007. Tears are inevitable.

On the other hand, with the idea in mind that you can construct a reasonably safe dividend-oriented, relatively diversified stock portfolio going forward, which provides a yield well above that, AND with decent potential for dividend growth, I screened the S&P 500 for stocks yielding above 3%, in market-leading names I recognize, and with decent (more than 10%) returns on invested capital (ROIC).

Here's the list I came up with, that I think will outperform the S&P500 significantly in total return over the next two years:

The only name that doesn't strictly meet that criteria is General Electric, which has a relatively low return on invested capital, given the capital intensive nature of its business and its past actions as, effectively, a bank.

The dividends all appear reasonably safe with these companies, as they have either relatively moderate payout ratios, or have recently lifted their dividend payments.

The last thing to consider is the potential impact of climate change on these companies over the short to medium term. In my view, none of them have the potential for short-to-medium term implosion, like I detailed for Compass Minerals.

However, some have a bit of climate-change short-to-medium-term risk as I see it, as discussed below:

Altria is a cigarette manufacturer/retailer. It is possible that climate change could affect their business in two ways:

Firstly, smokers tend to be in the lower economic strata; these are the folks who will be most effected  by potential food inflation. If they are spending more for food, then less is available for things like cigarettes which, despite their addictive qualities, are still a discretionary purchase. Some smokers may choose to quit if their budgets become more squeezed, accelerating the already evident trend of sales degradation, or they may trade down to lower margin brands.

Secondly, its possible that there could be some tobacco crop failures going forward (drought or too much precipitation/at wrong time), resulting in higher input costs. This would put Altria in the unenviable position of a margin squeeze, or having to hike prices (resulting in sales loss), or consumers trading down to cheaper brands.

On balance, I would rate their short-to-medium-term climate risk issues as moderate.

Heinz is a food manufacturer who could also be affected moderately over the short-term in a manner fairly similar to Altria. While consumers are unlikely to quit Heinz's type of product (they still need to eat), they may well trade down to cheaper brands with lower margins. Secondly, crop failures could also have a similar impact as described to Altria, above.

Sysco has moderate short-term climate risk, since they are a food distributor who supplies many restaurants. If food inflation picks up, then the general consumer will spend less on restaurant meals, meaning that many of Sysco clients could reduce volumes/orders (lowered revenue for Sysco) and suffer some financial distress (meaning Sysco's accounts receivables could also balloon).

Procter and Gamble is the final one which I believe also has some short-to-medium term climate risk. If food inflation occurs, and leaves fewer dollars on the table of their customers, then their customers may very well trade down from the PG family of premium products, to more economically priced ones.

On balance, I would say that this portfolio probably has average climate-change risk on a go-forward basis.

Disclosure: No positions.

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