CHICAGO, Aug. 18, 2011 /PRNewswire/ -- Today, Zacks Investment Ideas feature highlights Features: Johnson & Johnson (NYSE: JNJ), iShares S&P U.S. Preferred Stock Index (NYSE: PFF) and Buckeye Partners LP (NYSE: BPL).
Income Investing in a Low-Yield World
What kind of rate would you require on your investment? Would you lend that institution your money for 10-years at a measly 2.3%? That return likely won't even keep up with inflation.
Conversely, the earnings yield on the S&P 500 is currently 8.0 based on a forward price to earnings ratio of 12.5. Granted, returns over the last 10 years have not been great for most stocks, even for many blue chips, but much of the reason is that 10 years ago, those stocks were wildly overpriced. That doesn't seem to be the case today.
Moreover, the average dividend yield of the 30 Dow Jones Industrial Average components is a solid 3.1%. And there are several blue-chip stocks with strong cash flows, stable businesses and excellent credit ratings. Also, these companies often raise their dividends annually, unlike bonds which pay a fixed coupon.
If you're still leery of investing in stocks, there is a way to get the best of both worlds: preferred shares. Preferred shares are hybrid securities that act like bonds in that investors get a fixed payment, but still represent ownership in a business like a stock (although they typically don't get voting rights). Moreover, some preferred shares are convertible to common stock if a company's share price takes off, providing unlimited upside potential.
The dividends on preferred shares take priority over their common stock cousins, but interest payments on debt take the first priority. Nonetheless, if you're willing to shoulder a little bit more risk, preferred shares can offer attractive total returns.
If you're willing to invest overseas, yields on some foreign bonds, like Brazil and Australia, are very attractive right now. The central banks of many of these countries are actually trying to slow down their economies by raising interest rates.
And countries like Canada and Australia have much better balance sheets than the U.S. (and AAA credit ratings from Standard & Poors).
MLPs, REITs, BDCs
There's nothing like the threat of taxes on a business to get them to shell out cash to their owners. Master Limited Partnerships (MLPs), Real Estate Investment Trusts (REITs) and Business Development Companies (BDCs) all have to pay out at least 90% of their earnings to unitholders in the form of distributions to avoid paying taxes on that money. This way that money avoids double-taxation, which can lead to some juicy yields.
Many of these entities are in highly volatile industries, however, so their distributions often get cut during recessions. But not all of them do. In fact, many MLPs, REITs and BDCs actually raised their distributions during the Great Recession.
For income investors, I recommend a mixture of these different income-generating investments. Here are 4 specific ideas within each category above:
Blue Chip Stock Recommendation:
Johnson & Johnson (NYSE: JNJ)
Dividend Yield: 3.5%
Earnings Yield: 7.7%
Is its dividend safe? Well, considering Johnson & Johnson has over $27 billion in cash and short-term investments on its books, and it has generated over $10 billion in free cash flow each of the last 5 years, I'd say so. The company will pay out approximately $6 billion in dividends this year.
J&J has also raised its dividend every year for the last 49 years, and since 2001 it has raised it at a compound annual growth rate of 12.4%.
Oh, and Standard & Poors recently reaffirmed J&J's credit rating at AAA. Seems a lot more attractive than Treasuries to me.
Preferred Stock Recommendation:
iShares S&P U.S. Preferred Stock Index (NYSE: PFF)
Dividend Yield: 7.3%
PFF is an ETF that seeks to track the performance of the S&P 500 Preferred Stock Index. Its 7.3% dividend yield looks awfully attractive in today's low interest rate environment. Additionally, that yield is the composite of nearly 250 holdings, so investors get the benefit of some diversification.
Foreign Bond Recommendation
BlackRock Indexed Australian Bond
Yield: 5.5% (average as of June 30, 2011)
Believe it or not, there are developed countries out there with healthy economies and relatively solid balance sheets. Australia is a land rich in natural resources and has certainly benefited from the recent surge in commodities. But Australia is much more than just a mining and agriculture economy. The services sector actually accounts for nearly 75% of GDP, including a very stable financial services industry.
The country of 22 million people has experienced a remarkable 20 consecutive years of economic growth, even in spite of the global financial crisis.
Bond yields are high because the Reserve Bank of Australia currently has its cash rate set at 4.75%. And unlike the U.S., Australia has a AAA credit rating from S&P.
Buckeye Partners LP (NYSE: BPL)
Distribution Yield: 6.6%
Buckeye Partners LP is a Master Limited Partnership that receives petroleum products from refineries, connecting pipelines and marine terminals, and transports those products to other locations. It has a market cap of $5.8 billion and is headquartered in Houston, Texas.
The partnership has consistently paid, and raised, its distribution since going public in 1986. Since 2004, BPL has raised its distribution every quarter, including throughout the Great Recession.
The Bottom Line
With interest rates expected to stay depressed for quite some time, income investors need to explore other options. These 4 investments offer much more attractive returns.
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