I hope you are finding this income portfolio as useful and interesting as I am so far. Our attempt to find Ben Graham-suggested 30 stocks with dividend yields higher than the market itself and above many of the high-dividend ETFs is proving to be an exercise.
We have eight stocks in the mix so far, and we will have to pull out all the stops to find enough stocks to fill out the portfolio. A few years ago, just the Graham two factor and three factor models would have filled the portfolio out quite nicely and quickly. A continued period of zero rates and inflated asset values, however, is making the task a bit more challenging. We are going to have to dig deep into our box of proven anomalies to make this work.
I am going to use the work of Professor Robert Novy-Marx today to find quality stocks that pay decent dividend yields. Marx wrote a paper called The Other Side of Value. He found that stocks that had high operating levels of gross profits when compared to the total assets used to generate the profits outperformed the overall market. They also did about as well as classic value stocks.
His paper found that "Profitability, measured by gross profits-to-assets, has roughly the same power as book-to-market in predicting the cross-section of average returns. Profitable firms generate significantly higher returns than unprofitable firms, despite having significantly higher valuation ratios. Controlling for profitability also dramatically increases the performance of value strategies, especially among the largest, most liquid stocks."
I used the Graham number as the controlling valuation factor. I limited my search for those stocks where gross profitability was at least 33% of total assets and the price-to-earnings ratio multiplied by the price-to-book value was less than Graham's desired 22.5 maximum.
The largest company on the list is Chevron (CVX). While we may well see some future volatility from oil price swings I think the long-term potential of this company is quite high. There has been some concern that the oil and gas giant will cut the dividend, but I doubt that it will. Management is never willing to take that step unless oil falls into the $20s for a long period of time.
They did suspend the buy back and will be looking to cut back on capital expenditures and reducing exploration until oil pricing firms up. The PE times the price-to-book ratio gives us just 14.4, so the stock is undervalued based on the Graham calculation. At today's price we earn a little more than 4% on shares of Chevron, so it's a good fit for an income portfolio.
Houston Wire and Cable (HWCC) is in a really basic business as they are one of the one of the largest providers of wire and cable in the U.S. market. The business is sensitive to economic conditions and demand has been soft for a couple of years, But when the economy picks up, so will the stock.
They do a lot of business with the energy and infrastructure markets and both of those are soft right now, but should see increased spending over the next few years. The Graham number is 17, so we have some room before the stock is no longer undervalue. At the current price the yield is 5.29%, so we get paid to wait for improving conditions to move the stock toward the previous highs in the low teens, a nice gain from today's level.
Calamos Asset (CLMS) management offers mutual funds and other investment management products. While the firm has a specialty in convertible securities, they also offer wide range of fixed income and equity products to both individual and institutional investors.
The company comes in with a Graham number of 21, so it is just below the Graham cutoff. I think the 4.95% yield is safe and Calamos has a high level of insider ownership, so management has the same motivations that we do as shareholders. It is a solid choice for a dividend portfolio.
This used to be a lot easier but lofty valuations are making it a lot tougher to find enough cheap stocks to fill our portfolio. We will see on Thursday what other tricks I can use to find the additional 14 names I need so I can be fully invested in safe and cheap income stocks in a tricky market.