There comes a time in the lives of most investors when they realize the carefree days of investing in speculative growth stocks and trading in and out of equities before the bytes of the last trade fade on the screen aren’t reliable ways to generate income once they retire. Smart investors on the brink of retiring begin to search for ways to generate steady income with low risk of loss on their investments.
It’s an increasingly difficult transition in the current market with a shrinking pool of high-yield bonds and equities at acceptable risks. The Fed has backed savers into a corner with policies creating microscopic returns on saving accounts and CDs, forcing investors to look for yield at increasing levels of risk. The return on a 10-year Treasury is about 2.5%. If you had $1 million looking for a risk-free retirement parking place and you bought the 10-year, you would be living not-so-large on $24,800 per year. Sound like a great way to spend your golden years?
Over the past couple of years, investors desperately seeking yield have turned to equities. They take on more risk for better returns and what they get is a hot stock market and lower dividend yields. The investment landscape is all rocks and hard places and turning over a lot of rocks is the only way to start putting together a decent portfolio. The market is beginning to crack and volatility is up. Now is the time to start sifting through high-dividend payers looking for port-worthy investments. Not all dividend stocks are created equal.
What to look for:
- Yield above 3.5%
- Record of rising dividends
- Sustainable payout ratio
- Low debt
- Consistent free cash flow
- Low capital spending needs
- Stable business and demand
- High free cash flow yield
- Low enterprise value/revenue (EV/EBITDA)
Three consistent dividend-paying stocks
All three of these companies’ growth stalled in the past year, but they continue to pay a reasonable yield and have positive free cash flow with manageable debt. In fact, both Garmin Ltd. (NASDAQ:GRMN) and Paychex, Inc. (NASDAQ:PAYX) have no debt. Landauer Inc (NYSE:LDR) took on uncharacteristic levels of leverage in 2012 for an acquisition after years of no borrowings. Garmin has the lowest payout ratio suggesting it may have room to pay more.
Income with low risk
Garmin Ltd. (NASDAQ:GRMN) provides global positioning systems that use satellite technology to pinpoint the users exact location. The company has outdoor, fitness, marine, automotive and aviation products and applications. As competition increases and the market matures, the company’s best growth is behind it . Revenue peaked in 2008 along with the share price and has been in decline ever since. However, the rate of revenue decrease has decelerated and it looks like it may find equilibrium. Garmin Ltd. (NASDAQ:GRMN) has no debt and predictable positive free cash flow with a multi-year history of increasing the dividend.
The stock price has never approached the 2007 and 2008 highs of $120 and never will. It’s currently near a 52-week low at $36 and the dividend yield is 5.2%. If revenue stabilizes, current cash flow should support at least the recent annual dividend payout. It will never make an investor rich, but could provide income with low risk of capital loss. Garmin Ltd. (NASDAQ:GRMN)’s low operating margin will increase as a one-time charge works its way through last quarter.
High payout ratio
Landauer Inc (NYSE:LDR)’ s radiation-monitoring business is mature with little chance of substantial growth. It has added to the core business and acquired a medical- physics segment and a medical-products unit. The company was debt free for nearly a decade before taking on debt for acquisitions. The new business has added revenue but decreased margins.
Cash from operations continues to increase in spite of lower margins and barring more acquisitions, capital spending has stabilized at around 40% of cash flow. Free cash flow is positive and the dividend has a long track record of payment. It increased every year until 2012. The yield is 4.5%. The payout ratio often treads into very high near-100% territory and increases in the dividend may be few and far between. It is selling near a 52-week low but at higher valuations than it probably deserves.
Rising dividends
Paychex, Inc. (NASDAQ:PAYX) works in human resources managing payrolls and taxes for mainly mid-sized businesses. The recession was difficult, but revenue and earnings are recovering along with the price per share. Of the three, it trades at nearer the 52-week high than the low and the yield has dropped to 3.6% from its average 4.1%. Paychex has no debt and given its asset-light model, capital spending is on the low side providing consistent free cash flow. Dividends have been increasing for three years as Paychex, Inc. (NASDAQ:PAYX) recovered from the recession.
Comparisons
All three have predictable free cash flow and stable businesses. None will grow and make an investor rich with capital appreciation. The companies are mature. Garmin Ltd. (NASDAQ:GRMN) with its high free cash flow yield and 5.2% dividend yield is the most attractive income candidate of the three. It also benefits from zero debt and to seal the deal, it’s selling at a discount compared to Landauer Inc (NYSE:LDR) and Paychex, Inc. (NASDAQ:PAYX) with the lowest PE and EV/EBITDA.
The yields are higher than a 10-year Treasury, but it goes without saying, an investor has no guarantee of not losing capital. There is no risk-free free lunch in the search for yield. Of course we can always wait for the 10-year yield to pay us a living wage, but it could be a long time coming. A better strategy is to begin the hunt and turn over enough rocks to build a respectable retirement portfolio.
jean graham owns shares of Landauer Inc (NYSE:LDR). The Motley Fool recommends Paychex, Inc. (NASDAQ:PAYX).
The article Prep Your Portfolio for Yield originally appeared on Fool.com.
jean is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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