A few weeks ago, CAPS player Valyooo started a lively debate with a blog entry asking for opinions on stocks vs. high-yield bonds. Since then, the Fed has hinted that the easy-money flow might be slowed a bit and interest rates have climbed. Let’s do a little digging to try and find an answer, or at least add some color to the question.
The junk
First up, some high-yield or junk bonds. Junk bonds carry low credit ratings and unlike treasuries or high-grade corporates, there is a non-negligible risk of default. Therefore, investors demand higher interest rates because of the greater risk. A search at FINRA.org for corporate bonds with 5% to 10% yields and eight to 12 years until maturity turned up more than 500 hits, including the five in the table below. These five are issued by publicly traded companies and have credit ratings near the top of junk.
| Issuer | Price Per $100 Face Value | Yield | S&P Rating | Matures |
|---|---|---|---|---|
| Markwest Energy Partners | $91.00 | 5.69% | BB | 7/15/2023 |
| HCA | $100.00 | 5.87% | B- | 5/1/2023 |
| CenturyLink | $100.75 | 5.69% | BB | 3/15/2022 |
| Goodyear Tire & Rubber | $104.00 | 6.27% | B+ | 5/15/2022 |
| Advanced Micro Devices | $97.00 | 7.97% | B | 8/15/2022 |
Source: FINRA.org.
Only Advanced Micro Devices lost money over the past year and analysts predict all five issuers will be profitable over their next fiscal year. All five companies are highly leveraged with debt, which doesn’t leave a lot of room for a bad business cycle.
Junk bonds also offer a chance for capital appreciation if the issuing company’s business improves to a point where the debt rating improves. For example, if the auto business grows and creates tire demand, Goodyear’s business should improve and may get strong enough for an upgrade in the credit rating. If that happens, the bonds would trade up in price comparable to other issues with similar ratings.
The equities
I put the Fool’s stock screener to work with the following settings to find some high dividend yields
Dividend yield greater than 5%
Market capitalization greater than $1 billion
Trailing price-to-earnings ratio positive and less than 20
CAPS rating of 4 or 5 (out of 5) stars
The screen returned 65 hits, including the five summarized below.
| Company Name | Current Dividend Yield | Price-to-Earnings Ratio (TTM) | Sector | CAPS Rating |
|---|---|---|---|---|
| Annaly Capital Management, Inc. (NYSE:NLY) | 12.7% | 7.4 | financial | 4 |
| AstraZeneca plc (ADR) (NYSE:AZN) | 8% | 10.5 | health care | 4 |
| El Paso Pipeline Partners, L.P. (NYSE:EPB) | 5.7% | 19.9 | basic materials | 5 |
| National Grid plc (ADR) (NYSE:NGG) | 7.1% | 12 | utilities | 5 |
| TAL International Group, Inc. (NYSE:TAL) | 6.1% | 10.9 | services | 5 |
Source: Motley Fool stock screener.
Annaly Capital Management, Inc. (NYSE:NLY) is a real estate investment trust, or REIT, specializing in mortgage securities. As long as a REIT distributes at least 90% of its earnings to shareholders, it doesn’t pay income tax, which is why the yields tend to be high. Annaly Capital Management, Inc. (NYSE:NLY) and other mREITs buy mortgage-backed securities using leverage, i.e., they borrow short-term money and use it to buy the MBS. Profits come from the spread between the cost of funds and the yield on the MBS. Annaly Capital Management, Inc. (NYSE:NLY) recently cut its dividend as the interest rate environment is getting tougher for mREITs.
Pharma firm AstraZeneca plc (ADR) (NYSE:AZN) has a goal of maintaining or growing its dividend every year and targets 50% of earnings as its dividend payout. The payout ratio is currently at 62% and analysts are predicting decreasing earnings over the next few years.
El Paso Pipeline Partners, L.P. (NYSE:EPB) is a natural gas pipeline master limited partnership and is a member of the Kinder Morgan family. The partnership operates its network of pipelines like a toll road for transporting natural gas. Its first distribution was recorded in January 2008 and every quarter since has been a higher payout.
National Grid plc (ADR) (NYSE:NGG) is an electric and natural gas utility operating in the U.K. and northeast U.S. In a recent update to its dividend policy, the company is targeting dividend growth rate equal to inflation. Dividends are paid twice a year and recent history has been high yields with some small ups and downs. My Foolish colleague Jim Royal holds National Grid plc (ADR) (NYSE:NGG) in his World’s Best Dividend Portfolio.
Finally, TAL International Group, Inc. (NYSE:TAL) leases shipping containers. The company’s dividend history shows a drop-off to a penny per share quarterly in 2009 and then back up and it’s been climbing nearly every quarter since.
Conclusion
This is a tough call, the bonds and stocks both offer yields well above treasuries, high-quality bonds, or broad stock market indexes. There are different risk profiles for stocks and bonds, but the amount of risk seems comparable. I have to give the edge to stocks. I’ve got a long investing horizon and the potential for dividend growth and capital appreciation from stocks outweighs the stable income of the bonds.
Of the investments profiled, TAL International Group, Inc. (NYSE:TAL) is the most interesting. It’s turned up in a few high-yield searches and recovering economies around the world should drive trade and demand for containers. I’ll be adding TAL International Group, Inc. (NYSE:TAL) to my scorecard with an outperform CAPScall.
The bonds and stocks profiled should be considered representative of high-yield investments available in the market and not outright buy recommendations. Rewards from high yields typically come with risks like missed payments or defaults, market fluctuation, and dividend cuts.
The article High Yield: Stocks or Bonds? originally appeared on Fool.com and is written by Russ Krull.
Russ Krull has no position in any stocks mentioned. The Motley Fool recommends El Paso Pipeline Partners and National Grid (ADR).
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