Since my last column, the economic turmoil that has engulfed much of the world's economy, remains unabated. An illustration as to how big the problem is can be found in a calculation from Bloomberg, the news and financial data company. It figures that the Federal government has pledged the astounding (astounding at least to me) amount of $7.76 trillion, equal to half the country's gross domestic product. The bailout includes a program to buy as much as $2.4 trillion in short-term notes, and $1.4 trillion from the Federal Deposit Insurance Corporation to guarantee bank-to-bank loans. Likely, the government will be repaid some of its loans and retain value for some of its equity investments, so the final cost to the government may be considerably less than Bloomberg's total. But the total shows how much the government is potentially on the hook for, and it's a scary number.
In times like these, I think investors need to steer clear of companies which heavily rely on debt because of the risks inherent with leverage. Financially conservative companies will weather the storm the best. Even better are financially conservative companies which provide solid dividend yields. Such companies' stocks produce good cash flow (via their dividends), while investors wait for the market to turnaround.
Earnings have generally gotten more attention from investors than dividends, but in today's market, some are giving more emphasis to dividends. The Wall Street Journal recently quoted a London fund manager as saying: "The lesson of history, one from which investors should take comfort, is that dividends are much more resilient than earnings. In fact, dividednds have risen this year, in contrast to an earnings decline in Europe."
In my last column, I recommended two companies, Telenor (TELNY) and BASF (BASFY), with fairly high divident yields, because I believe that pursuing stocks with high dividend yields from companies able to sustain their dividends is a viable strategy in today's market. I still think so. Let me now tell you about two more companies that are financially conservative, but whose stock prices are battered down, which results in high dividend yields.
Probably no investment guru has ever emphasized liquidity and conservative financial management more than the legendary Benjamin Graham (who was, by the way, Warren Buffett's mentor). He is the one who said a company's current ratio (current assets compared with current liabilities) needs to be 2 or more. He wanted a lot more current assets than current liabilities because he did not want companies to find themselves in trouble and then being unable to pay their debts. As it happens, these are the kinds of companies who should do well in the current market.
One Graham favorite is Pfizer (PFE), the global pharmaceutical company, whose list of well known products include Zoloft, Caduet, Lipitor and Viagra. Its dividend yield is 8.2%. The Guru Strategy I created based on Graham's writings thinks Pfizer is in good health. It has large sales (over $48 billion, annually), and is highly liquid, with a current ratio of 2.24:1 (current ratio is current assets compared to current liabilities). And its long term debt is less than one-third its current assets. This is a company with plenty of money. To test the stock's price, the strategy looks for a P/E ratio, using the average of the P/E over the past few years, of not more than 15. Pfizer's is 12.9, suggesting the stock is very reasonably priced. One further test is multiplying the price-to-book ratio by the P/E, and requiring that it not exceed 22. This is a test measuring how much you are paying for tangible assets. In Pfizer's case, this comes to just under 21. Financially solid and a good dividend yield sums up Pfizer.
The second company I would like you to look at is Rolls-Royce Group (RYCEY). Do not confuse this jet engine maker with the car maker. They were once the same company, but split up years ago, and the cars made under the Rolls-Royce name are now made by BMW. The Rolls-Royce Group is based in Britain, and makes jet engines for the likes of Boeing and Airbus, both of which have delayed the shipment of new plane models, which has resulted in layoffs at Rolls. Yet, long-term prospects for the company are good. Its stock yields 9%, and my Ken Fisher-based Guru Strategy thinks this company should have plenty of propulsion behind it. The Fisher strategy considers Rolls a "super stock," in part because its price-to-sales ratio is only 0.68. This means you are paying 68 cents for every dollar of sales, which is a real bargain. Plus, the company is strong financially. Graham would probably like how Rolls' management has managed its finances, since it's debt is only 28% of its equity, a measure important to Fisher as well. In addition, it has $0.44 worth of free cash per share, and a strong net profit margin of 9.13%. Cash and solid profit margins are what you want when the economy is weak.
Both Fisher and Graham like fiscal conservatives, and so do I at this time. Pfizer and Rolls pay high dividends, while standing on solid ground, financially. Today's market makes it tough for investors to take a risk by buying stocks. Of course, there is no guarantee the stock prices of these two companies won't decline over the short term. But over the long term, both companies should perform well, and while you wait, you will be rewarded with very nice returns from your dividends.
Published by Globes [online], Israel business news - www.globes.co.il - on December 10, 2008