All Dividends Are Not Created Equal

 | Apr 08, 2013 | 10:30 AM EDT
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The various programs initiated by the Federal Reserve over the past several years have successfully pushed investors into riskier assets in search of yield. High-yield bonds are selling at all-time low levels, and even yields on 10-year Treasuries have fallen to about 1.7% over the last few weeks from nearly 2.1% on March 11. (The bond market seems to be more skeptical of economic and job growth than the stock market). Income investors have also recently bid up traditional defensive dividend-paying sectors like telecoms, utilities and consumer staples significantly. This has left these sectors trading at a premium to the overall market and put them at the high end of their historical valuation ranges.

I believe income investors are engaging in more risk than necessary to capture a 3% to 4% dividend yield. They would be better served looking at less traditional dividend-paying sectors like technology. Tech companies have not been big dividend payers historically; however, between 2007 and 2012 the proportion of dividends coming from the tech sector within the S&P 500 has grown to 14% from 6% of the total. Major tech firms such as Cisco Systems (CSCO) and Intel (INTC) have hiked dividends substantially over the years and now pay a yield similar to what can be expected in utilities and consumer staples, and sell at a much lower valuation.

To demonstrate how wide the disparity has become, let's compare a key component from sector: Procter & Gamble (PG) vs. Microsoft (MSFT).

Valuation: Microsoft trades just over 9x forward earnings and the stock sells near the bottom of its five-year valuation range based on price-earnings, price-sales, price-cash-flow and price-book ratios. Proctor sells for just below 18x forward earnings and is at the top of its five-year valuation based on PE, PS, PCF and PB ratios. Advantage: Microsoft

Dividends: PG pays a dividend of 2.9%. The company has raised dividend payouts at just over an 8% compound annual growth rate over the last five years. Microsoft pays a heftier yield of 3.2% and has increased payouts more generously over the past half-decade, with a 16.5% CAGR. Advantage: Microsoft

Growth: Analysts expect Mr. Softy to grow revenue at approximately 8% annually over the next two years. The stock sells for a very reasonable five-year projected price-earnings-growth ratio of 1.11 for a 3% yielder. In contrast, PG is tracking to a little more than a 1% sales increase in full-year 2013. Projected revenue growth in 2014 is little more solid at 3% to 4%. The stock also sells for a substantially higher five-year projected PEG of 2.49. Advantage: Microsoft

Balance Sheet: P&G has a very solid balance sheet (AA-) with substantial cash flow to cover its more than $30 billion in net debt on the books. But Microsoft is one of four companies in the S&P 500 with a higher credit rating (AAA) than the U.S. Government. It also has some $60 billion in net cash and short-term marketable securities on its balance sheet. Advantage: Microsoft

This is one example of many surrounding the divergence between these two groups. Income investors should practice solid due diligence and look to other tech stalwarts to award a larger allocation of their income portfolio.

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