Break Out the Barbell, Part 2

 | Mar 01, 2013 | 3:00 PM EST  | Comments
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Stock quotes in this article:

glw

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cma

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key

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aapl

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csco

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cy

I wrote on Thursday about how to put together an income portfolio in this very confusing market. The Federal Reserve's Zero Interest Rate Policy the past few years has made it more difficult for investors to find the income to support their lifestyles or investment needs. I favor eschewing the current offerings and ideas from the Wall Street marketing machine and building an income barbell to secure needed investment income. The first part is to put together a portfolio of very high-yielding, alternative income selections such as REITs, BDCs and other income vehicles. As I said yesterday, buy them below asset value and buy lots of them.

The second part of the barbell is to find companies that pay a decent dividend today but have the ability and probability to grow the dividend at a very rapid rate over the next five to 10 years. The absolute level of the dividend today is not as important as the level of the payout in the future. I look at these stocks like 10-year bonds with accelerating coupons.  You have to accept that they will be far more volatile than bonds, but as long as the company can survive a decade and grow the dividend, it will provide growing income to offset the rising cost of living and potentially offer capital growth as well.

They key for those who have traditionally invested in fixed-income markets and now find themselves forced into stocks is to learn to buy smart and hold for a long time. Day-to-day price fluctuation can be unnerving when you are used to bank statements with CDs that have no principal fluctuation. There is far more psychology in equity markets and that will cause greater fluctuations. Learn to make them work for you by buying into large declines and resisting the urge to chase exciting markets and story stocks. Scale into stocks and plan on owning them for a long time to let the growth of the dividend payout provide the income growth you need to meet your future cash needs.

I ran a screen of companies with both the ability and high probability of growing dividends at a high rate.  Note that the tech giants make the grade here as they have high rates of cash flow growth and lots of cash on the books. Apple (AAPL) actually makes the grade since, in spite of paying just 2.4% right now, it could easily double the dividend several times over the next few years. Cisco (CSCO) is on the list with a 2.7% yield but huge cash stockpiles and growing cash flow could lead to rapid payout growth. Cypress Semiconductor (CY) sports a decent yield of more than 4% but has plenty of cash and cash flow, and the payout should grow well above average for an extended time. You should eventually own all of these in an income barbell portfolio, but buying right is critical with the tech dividend stocks. Buy them during a panic and hold on for as close to forever as possible.

Corning (GLW) makes the grade as well with a yield of 2.90% and an ability to grow the dividend at a fast pace for most of the next decade. I try never to fall in love with a stock story, but I am fond of Corning's potential. Its glass, fiber and cable products are used in economic sectors that I expect to experience very high rates of growth over the next decade. As its business grows, so will the dividend payout.

Banks are also strong candidates for the dividend growth portion of your income account. Many banks eliminated or cut dividends to preserve capital during the credit crisis but we are seeing payouts reinitiated and hiked as the economy improves. The worst of the credit problems are behind most of these banks and balance sheets are improving. Comerica (CMA) is a great bank with a strong presence in key markets like Texas and has a current yield of just 2%.The payout ratio is less than 30% of profits after hovering above 50% for much of the decade before the crisis. It can increase the payout rapidly in the next decade.

KeyCorp (KEY) is one of my favorite large regionals and the yield is right around 2% as well. The current dividend is just $0.20 a share annually, down from a high of $1.46 so there is lots of room to grow the payout. Dozens of banks should experience improvements in business conditions over the next 10 years. As they do, your yields will increase.

The key to making this portion of the barbell work is to select strong companies with low payout ratios and buy them on the cheap. Buy when others are selling and hold them. Try to the largest degree possible to ignore the day-to-day fluctuations and noise from the stock market. Your goal is 10 years from now, not this afternoon's close.

Using a barbell approach provides high current yield to a portion of your portfolio right now and a portion that provides a high rate of income growth. Blending them together should give you a return far in excess of most fixed income and Wall Street-generated income products, and allow you to grow both your income and principal over the next decade.

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