Bad News for Income-Seeking Investors

 | Aug 31, 2016 | 2:00 PM EDT
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Charles Evans, head of the Chicago Fed, spoke yesterday in China and lobbed a bomb in the direction of income-seeking investors. He sees the U.S. as undergoing a period of long-lasting lower growth along the lines of Larry Summers' "secular stagnation" theory and says low rates may be here for an extended period of time. He speculated in his speech that an aging population and lower productivity mean low rates could stay far longer than anyone could ever have expected. He further suggested that any near-term rates hikes would simply flatten the yield curve rather than actually lead to higher rates and would also introduce uncertainty in the financial markets.

If he turns out to be right, and there are plenty of clues in recent economic news to suggest he might be, this is horrible news for income-seeking investors. It is especially horrible for anyone approaching retirement today and has a slug of money they need to put to work generating income right away. The yield hunt has been going on for a long time and many traditional income alternatives have been pushed to unsustainable valuations. Most blue-chip stocks trade at what I think are borderline ridiculous multiples of assets and earnings, and although I am a huge fan of REITs in general it is getting hard to find bargains in the sector. A blend of strategies is going to be required to find a yield portfolio that provides adequate cash flows and still has a decent margin of safety.

The first approach is going to be using a combination of Ev/EBIT ratios and Piotroski F-scores to find dividend-paying nonfinancial companies at bargain prices that have strong fundamental positions and decent prospects over the next few years. I set my yield cutoff at 3.5% and only looked at companies that paid more than that. My EV/EBIT ratio limit was 8, which is about half the broad market current average valuation. Passing companies also had to have an F-score of 5 or more.

It is not a long list of stocks. I have been saying for some time that it is getting very hard to find cheap stocks, and every screen I run shows fewer names every week, but there are some names worth considering. Just 19 U.S. stocks passed all three filters.

Four of the companies on the list were in the energy sector and the last thing a safety-conscious income investor wants right now is an overexposure to oil and gas, so I would select the one with the highest F-score. Right now, that would be refiner Valero (VLO) . The company owns 15 petroleum refineries with a combined through-put capacity of approximately 3 million barrels per day and also sells refined products through about 7,500 locations in the U.S. The company earns an F-score of 6 and trades with an EV/Ebit ratio of just 6. The yield at the current price is 4.3%, so it is a decent candidate for an income portfolio.

Liberty Tax (TAX) provides tax services as well as refund payment solutions in the United States. In addition to its franchise operations, it also offers online tax preparation services. The company has been rowing nicely this year and analysts expect profits to double over the next year as well. The company is in fantastic fundamental shape and earns an F-score of 8. The yield is 4.57% and the Ev/Ebit ratio is just 6 right now.

An old favorite makes the list again. I have owned shares of Star Gas Partners (SGU) for so long I don't remember when I first purchased the propane and heating oil distributor. In addition to the energy business, it has a division that provides heating and air conditioning repair equipment for its customers and provides home services, including home security and plumbing, to approximately 25,000 customers. The company has rolled up a bunch of mom-and-pop propane and heating oil businesses in the Northeast into one of the largest heating oil distributors in the United States, and shareholders have been well rewarded. Shares are trading with an Ev/Ebit ratio of 7.8 and an F-score of 6, so this seems likely to continue. Right now the shares yield 4.56% and management has a good history of dividend increases over time.

The search for yield at a bargain price is becoming more difficult every day. If Charles Evans is even close to right about interest rates, it is not going to get easier any time soon. Investors need to be cautious and use a wide net to find the right yield at the right price.

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