Fed killing bonds? Buy dividend stocks

@lamonicabuzz December 13, 2011: 12:00 PM ET
Shares of companies that pay solid dividends have held up well in what has been a volatile market in 2011.

Shares of companies that pay solid dividends have held up well in what has been a volatile market in 2011.

NEW YORK (CNNMoney) -- Interest rates are absurdly low and unlikely to head much higher as long as the U.S. economy remains stagnant and Europe remains, well, Europe.

But fear not income-hungry investors. Now is a great time to buy blue chip companies with steady payouts. Forget about Treasury bonds, the dollar, gold or other so-called safe haven bets. Dividends are the place to be.

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Ford (F, Fortune 500) just reinstated its quarterly payout after five years without one. The yield will be a respectable 1.8% -- not much lower than the yield on the benchmark 10-year Treasury.

Earlier this year, tech giant Cisco Systems (CSCO, Fortune 500) finally decided to put some of its "caysh" to work and started paying a dividend. It yields 1.3%.

And companies that are dividend stalwarts, such as Dow components Walt Disney (DIS, Fortune 500), General Electric (GE, Fortune 500) and Pfizer (PFE, Fortune 500), have all recently said they are boosting their dividends.

You have probably heard that these are "uncertain" and "volatile" times for the markets. And the Federal Reserve is punishing savers and bond investors by pledging to keep interest rates low for at least another year-and-a-half.

So why on Earth would anyone looking for safety in income buy a bond when they could a blue chip company with an even higher yield instead?

"There's a lot of risk in longer-term bonds. Treasuries will only do well if the world comes to an end," said Rex Macey, chief investment officer with Wilmington Trust in Atlanta. "You can't buy a 10-year with the yield at 2% and expect a real return. Quality dividend stocks are bargains compared to Treasuries."

Low interest rates have even hurt investors in corporate bonds. There are several top-notch companies, such as IBM (IBM, Fortune 500) and Johnson & Johnson (JNJ, Fortune 500), with debt outstanding which will mature in a few years that pay yields LOWER than the yields on their stock dividends. That's almost unheard of.

Fortune's 10 best stocks for 2012

Sure, these companies may not sound all that exciting. But have I mentioned how volatile this market is? Many expect it to remain so in 2012.

With that in mind, slow, steady and dependable sure beats the hot Wall Street darling growth stories -- especially when momentum suddenly fades. Just ask any investor who was caught with Netflix (NFLX) at its highs. Or Green Mountain Coffee Roasters (GMCR). Or OpenTable (OPEN). Or Crocs (CROX). The list goes on and on and on and on.

"Quality always endures. Boring is back," said Hank Smith, chief investment officer of equities at Haverford, an investment firm in Radnor, Pa. "The new fixed income is high-yielding stocks."

Smith said there are great dividend opportunities in most sectors, but he mentioned consumer staples titans like Home Depot (HD, Fortune 500), McDonald's (MCD, Fortune 500) and PepsiCo (PEP, Fortune 500) as particular favorites.

The allure of dividends is quite simple. Even if the economy is sputtering along and companies have the occasional quarterly sales or earnings hiccup, those that pay dividends should continue to do so -- and even increase them -- as long as they have the cash to back up those payments.

So it shouldn't be a major surprise that dividend stocks have outperformed the broader market this year. The iShares Trust Dow Jones Select Dividend (DVY) exchange-traded fund is up nearly 6% this year while the S&P 500 (SPX) is down 1%.

Industries that are known for big dividends have done even better. The Health Care Select SPDR ETF (XLV) is up 7% so far in 2011 while the Dow Jones Utility Average (DJU) is up more than 10%. Tobacco stocks Lorillard (LO), Altria (MO, Fortune 500) and Reynolds American (RAI, Fortune 500) have all surged this year. They have yields in the 5% range.

The lack of stability is a big reason why Macey and Smith both said they'd be wary of financial stocks however.

The Fed has given clearance to some big banks to start boosting their dividends, but it is not clear if the banks will be able to maintain those payments if the Europe mess forces them to raise more capital.

So the key to dividend investing is not to just to find the company with the highest yield. The yield, after all, is the dividend divided by the stock price.

A yield that is too high (say in the double digits) may be a red flag. If the company's stock price has plummeted due to worries about its financial health, the dividend may need to be cut to preserve cash. And any time a company cuts (or worse suspends) its dividend, investors tend to panic.

Nonetheless, experts said dividend stocks should continue to do relatively well as nervous investors look for any way they can to squeeze out a decent yield in this low-rate environment.

Smith, who only will invest in stocks that pay dividends, said he's hopeful that more tech companies with tons of cash and little debt will follow Cisco's lead and start issuing dividends.

Dividend stocks get new respect

Tech firms often get criticized for paying a dividend because growth investors would rather see cash used on research and development, acquisitions or other measures that could boost earnings. A dividend is viewed as a sign of (gasp!) maturity.

But some companies have so much cash that it's hard to fathom why they can't part with some of it and still have plenty left over for more sexy growth initiatives. Smith specifically mentioned a certain tech juggernaut with a staggering $81.6 billion in cash and investments on its balance sheet.

"If Apple (AAPL, Fortune 500) initiated a dividend, I would be hard-pressed not to buy it," Smith said.

Agreed. I last wrote about Apple when it had only $76 billion in cash. It's time has come. Sure, some might scoff that Apple would be joining the ranks of stodgy, old techs. But you'd have to think many Apple investors would welcome the news.

Dividends may not be as cool as an iPad 2. But they come pretty close in this crazy market.

Best of StockTwits: Another horrible earnings report from the inappropriately named Best Buy had traders acting like Grinches and Scrooges.

ki11tank: $BBY surprised they haven't downsized more or focused better. They'll never beat $AMZN... gonna be another fade out...

It is true. Many joke that Best Buy (BBY, Fortune 500) is nothing more than a showroom for Amazon (AMZN, Fortune 500). That's not good. Best Buy may not go the route of Circuit City. But you have to wonder if a PE firm might finally look to buy them. I wrote about that back in May.

Ktr8der: I don't know squat about retail, but $BBY has 10-20% of it's store space selling DVDs. How can that work? BBY is cheap though.

Netflix is "cheap' too. And rumor has it they have a DVD business.

bpeck: If $AAPL can make the economics of physical stores work, why can't $BBY?

Maybe because Apple only sells products made by Apple instead of also offering stuff from HP (HPQ, Fortune 500), Dell (DELL, Fortune 500) and RIMM (RIMM)?

agwarner: $BBY going to hire turnaround specialist Crazy Eddie http://www.youtube.com/watch?v=fO9XC3tAbkQ

Best Buy's stock price is so low ... it's insane!

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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