The Unlikely High Yielder
I just had a shocking revelation while reviewing my personal portfolio.
Since I’m Utility Forecaster’s chief investment strategist, you’d probably assume that an electric utility or MLP would be the highest-yielding stock in my portfolio.
Wrong! The highest-yielding holding in my portfolio is a tech stock. Yep, a tech stock.
Okay, that probably requires a bit of explanation.
You see, I HATE overpaying for stocks. Though I’ll concede that there’s no way to successfully time the market, every now and then I build up a cash hoard to take advantage of unexpected corrections. Even if the broad market doesn’t take a dive, there’s always a selloff somewhere.
Back in 2011, pretty much every investor still had a wounded psyche from the Global Financial Crisis. And with the tepid recovery, it wasn’t hard to imagine that the bear was lying in wait, licking his chops.
That year, there was a punishing correction that was reminiscent of what happened just prior to the downturn. Still bruised from that earlier experience, I was admittedly scared to step in and be the last buyer when literally every other investor seemed to be heading for the exits.
To counter the limitations of my own fearful psychology, I set stingy limits on the stocks that I wanted to buy. In fact, they were laughably stingy limits.
But volatility is a value investor’s best friend. As I was enjoying a late lunch, I casually checked my pending orders and saw that, to my surprise, they had all been filled. The market had really fallen off a cliff during the final hour of trading, and even my laughably stingy conditions had been met. I wasn’t sure whether to be elated or horrified.
In retrospect, I should have been elated. I established a position in Cisco Systems Inc. (NSDQ: CSCO) at $13.71. While the stock would eventually trade even lower as the summer progressed, at the time I thought it was a pretty good price for a company whose hardware helps form the backbone of the Internet. Today, the stock trades around $34 per share.
Equally important, that year Cisco had finally started paying a dividend. Yield chasers likely scoffed at the initial yield. Indeed, even at the deep-value price at which I picked up the stock, Cisco’s shares only yielded about 1.8%.
Since then, however, Cisco has nearly quintupled its payout. At current prices, the stock yields around 3.4% on a forward basis. But based on the price at which I bought Cisco less than six years ago, it currently yields 8.5%!
And with abundant free cash flow and a payout ratio of just 44%, there’s room for further dividend growth ahead. In fact, analysts forecast Cisco will grow its dividend 8.3% annually over the next two years. If the consensus forecast proves to be correct, then by 2019 my shares of Cisco will be yielding nearly 10%.
More Than Just Bragging Rights
There’s a reason I’m offering this example, and it’s not just to brag (well, maybe a little). It’s because it highlights our approach at Utility Forecaster.
Unlike when I first bought Cisco, most of the stocks that we recommend in Utility Forecaster already yield between 3% and 5%. One even yields more than 8%.
Too many income investors simply focus on current yield. But astute income investors focus on dividend growth. So now you can imagine how those yields can compound over time as our favorite companies grow their payouts.
Of course, Cisco has been on an absolutely torrid pace of dividend growth that most slower-growing utilities couldn’t possibly replicate. Even so, the fastest-growing utilities in our portfolios are on course to grow their dividends 8% annually, which is pretty good for companies already yielding around 3%.
And we do have a handful of names that operate in other areas that are on track to grow their payouts at a double-digit annual pace. Indeed, one of the newer MLPs that we recommend is forecast to grow its distribution by 22% annually through 2020.
The Cisco example also illustrates the importance of value. At Utility Forecaster, we don’t chase stocks higher, even if they’re our favorites. Instead, we wait for them to trade at compelling values before establishing positions or adding to existing holdings.
To be sure, when you focus on a single sector, especially one that provides essential services, you don’t get many opportunities to buy at bargain prices. But in any given year, a sector can suffer one or more corrections, and that’s when we pounce.
Not only do such corrections allow us to pick up solid stocks at more reasonable prices, they also give us an opportunity to lock in higher yields that are leveraged to future dividend growth.
With the Fed getting serious about rate-hiking again, we believe income investors will have more opportunities to pick up our favorite stocks at compelling values later this year.