Looking for Safety in Blue-Chip Dividend Stocks

Newcomers to stock market investing are sure to uncover the sage investing advice that dividend paying stocks offer a measure of protection in troubled times.  There is no question the equity markets are wildly volatile at present and the road is likely to remain rocky for an unforeseeable time.  Is there any truth within this advice or is this another of many investing maxims that look solid in theory but do not always hold up in practice?

The following graph is from US based Wealth Management Systems Inc. It compares the performance of a single dollar invested in dividend paying stocks and an equal amount invested in non-dividend paying stocks. The data is based on the US S&P 500 Index.

While both dollar investments appreciated, the dollar invested in dividend payers more than doubled the return generated by the non-dividend payer – $25 versus $12. However, you can see that even the dividend payers dropped in the challenging conditions in early 2001 and during the GFC.  So where is the protection?

First, the graph suffers from looking at the entire index, which washes out the high performers by averaging them with the low performers.  What investing experts tell us is that generally speaking, dividend payers fall less than non-dividend payers in stormy weather.  As an example, the following graph compares the performance of one of the top performing dividend stocks on the ASX, Westpac Banking Corp. (WBC) against a promising growth stock, Virgin Australia Holdings (VAH).

Certainly Westpac dipped but the bottom fell out of the Virgin share price.  Over the last five years Virgin has improved, with an average annual rate of total shareholder return of 7.3%, without dividends.  In contrast, over the same period WBC returned 12.5%.  The collapse of the price of oil is a welcome tailwind for Virgin shareholders as the company’s FY 2015 reported earnings per share (EPS) of $0.01 is expected to surge to $0.021 in FY 2016 and then more than double to $0.043 by FY 2017.

The theory behind the desirability of dividend payers makes sense, but in practice the key is to pick the best of breed among dividend payers.  The most common mistake made by novice investors is to look for the highest yielding stocks.

Investors who have done their homework know that dividend yield is a function of dividends paid and the price of the stock.  As the price of a stock falls, the yield rises, resulting in some highly risky stocks sporting huge yields, well over 10%.  There are a variety of measures to look at rather than yield alone, including historical dividend growth rates, forward looking dividend growth estimates, payout ratios, and earnings growth.

Where does one begin to look?  Stock screeners are good tools but a quicker way is to look at high-yielding blue chips favored by analysts.  This of course assumes the bullish views of the analysts will play out over time, which they often don’t.  For that reason, it is advisable to do some research on those favored stocks.

We begin with a screened list of the highest dividend yields from the top 150 companies on the ASX with a consensus Strong Buy Recommendation from analysts covering the company.  The dividend scan can be found on the Market Index website, a Perth-based publisher of ASX information.  Here are the five stocks that qualify for a further look.

Origin Energy (ORG) has a seemingly impressive yield that upon further review appears to be a reflection of the 67% year over year decline in the share price.  The future doesn’t look promising either, as it is the only stock in the table forecasted to see drops in both dividends per share (DPS) and earnings per share (EPS) over the next two years.  The dividend is unfranked, making it far less attractive than companies with fully franked dividends. So what do analysts see in this stock?

Origin is an integrated energy company that does much more than oil and gas exploration and production. The company generates and distributes electricity, gas, solar power, and hot water solutions to residential and business customers here in Australia and around the Pacific Basin Region.  Origin holds a controlling interest in New Zealand energy provider

Contact Energy.  Origin has a 37.5% interest in the Australia Pacific Liquefied Natural Gas Project (APLNG) which began shipping on 11 January of this year.  Conoco Philips also has a 37.5% interest with China’s Sinopec with a 25% interest.

Most investors are well aware LNG pricing is linked to the price of oil and Origin and its partners reportedly need pricing between $US38 and $42 dollars per barrel to make a profit.  However, the company has hedged some shipments at a price of $US40 dollars per barrel.  When you look at the complete picture, Origin looks promising on a long term basis.

For comparison purposes, our largest oil and gas producer, Woodside Petroleum (WPL) has a P/E of 15.17 and its 2014 reported EPS of 357.7¢ is expected to fall to 174.4¢ in FY2015 and crater to 47.1¢ in FY2016.

Once the red-headed step-child among the Big Four Banks, National Australia Bank (NAB) is about to shed its UK operations that have plagued the bank.  NAB officials expect the ability to focus on core operations here in Australia and New Zealand will more than offset the 3.8% of its revenue that came from the UK.

Despite challenging conditions associated with the UK business, NAB has a very respectable five year dividend growth rate of 5.7% and has raised its dividend in each of the last three years.  Although Westpac Banking Group (WBC) has a slightly higher growth rate over the last five years, the dividend for FY2013 of 191.6¢ fell to 179.8¢ in FY2014 before rising to 184.7¢ in FY2015. The NAB stock price is down 24% year over year.

Suncorp Group (SUN) is primarily an insurance company serving both consumers and businesses; but it has a significant banking operation as well.  For FY2015 General Insurance net profit after tax (NPAT) was $754 million, down from $1,010 million in FY2014 while the Banking operations saw its NPAT rise from $228 million to $354 million.

The stock price has dropped 22% year over year, with a 15 December 2015 announcement of a profit downgrade a major factor in the slide.  Here is a one year share price performance chart for SUN.

Sun has a respectable Price to Book (P/B) ratio of 1.09 and a Forward P/E of 11.48, well below the Sector average current P/E of 19.43.  This compares very favorably with rival QBE Insurance (QBE) with a P/B of 1.33 and a Forward P/E of 14.85.  QBE’s current yield is 3.8% and its five year dividend growth rate is a negative 18.8%.

IOOF Holdings (IFL) is a diversified financial services provider.  The company offers a variety of investment products along with investment advice, wealth management and retirement and estate planning services, and trustee services.

In late June of 2015 investors in IOOF Holdings were shocked to learn the company had appointed an independent adviser, PricewaterhouseCoopers (PwC), to investigate possible breaches of the financial services laws and its regulatory obligations.  The industry has come under fire, with calls for a formal commission to investigate.  The IOOF announcement followed a 20 June article in the Sydney Morning Herald entitled IOOF’s Boiler Room Throws Customers to the Wolves.

Predictably, the share price crashed and is now down 19% year over year.  Here is a one year price performance chart for IFL.

On 28 August the company reported positive earnings, with NPAT up 36.2%, propelling the share price upward, as you can see from the chart.  IFL has good numbers and analysts like it.  However, according to a 14 September article appearing in the Australian Financial Review (AFR) although IFL management in its FY2015 Full Year Financial release stated the Price Waterhouse findings and recommendations had been turned over to the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority, with a pledge to implement the report’s recommendations.

The AFR article claims the report and its recommendations should be fully disclosed, so investors can judge for themselves.  An ASIC investigation is still underway, which sounds like there may be another shoe to drop.

The final stock in the table is venerable Westpac Banking Group (WBC), the second largest of the Big Four Banks by market capitalization. The bank has rewarded shareholders well over the years, with average annual rates of total shareholder returns of 6% over three years; 12.5% over five years; and 9% over ten years.

Concerns about the future of this and the other banks play like a broken record, repeating with regularity over the past several years.  The Australian Prudential Regulation Authority (APRA) is concerned competition among the banks for the mortgage loans on which they rely so heavily will lead to riskier loans and resultant increase in bad debts.  We have heard that one before.  Once again there is speculation the APRA will raise the capital requirements of the banks yet again to scratch the ARPA’s itch.  There is talk of a recession finally finding its way to our shores.

All of these concerns are real, but not all of them are new.  We have heard of the property bubble bursting as well.  The recession talk is arguably stronger now.  However, the banks survived the GFC and with the exception of NAB have gone on to see share prices exceed their pre-GFC value.  Here is price performance chart comparing the two largest banks, Westpac and Commonwealth Bank of Australia (CBA).

Westpac may be worth a look as a long-term hold, despite the risks.