Investors: Search for Income!

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Today’s economic scene is rapidly becoming more and more difficult to navigate, especially for income investors.  According to a story from The Wall Street Journal:

Investors are desperate to get more income out of their mutual funds.  So desperate, they may be taking on more investment risk than they realize.

The story then goes on to explain:

Their desperation is easy to understand.  Yields of some types of bonds are at their lowest levels ever.  But many investors are chasing income by piling into just a few areas, as if those were the only choices left to them.  Through October, some $28 billion has flowed into U.S. high-yield bond mutual funds, about twice as much as in all of 2011, according to Morningstar Inc.

One solution is diversifying income-paying assets across a variety of asset classes.  Examples are energy MLPs, which are often backed by assets like pipelines, dividend-paying stocks, high-yield bonds, emerging market and international debt, and REITs.  You can use ETFs and a smattering of individual securities to diversify and keep costs low.

I cover energy dividend-payers in my follow-up post: “Investors: Continue to Search for Income!

But beware.  These instruments pay out greater yields than most treasuries, high-grade corporate debt, and municipal bonds – but they also have different tax consequences and risk profiles.

Here is a breakdown of potential healthcare, technology, and financial dividend-payers for an income portfolio.

<table> <tbody> <tr> <td> <p><strong> </strong></p> </td> <td> <p><strong>Dividend</strong></p> </td> <td> <p><strong>Forward P/E</strong></p> </td> <td> <p><strong>TTM P/E</strong></p> </td> </tr> <tr> <td> <p>Pfizer</p> </td> <td> <p>3.5%</p> </td> <td> <p>11.0</p> </td> <td> <p>19.7</p> </td> </tr> <tr> <td> <p>Johnson & Johnson</p> </td> <td> <p>3.5%</p> </td> <td> <p>12.7</p> </td> <td> <p>22.9</p> </td> </tr> <tr> <td> <p>Merck</p> </td> <td> <p>3.9%</p> </td> <td> <p>12.1</p> </td> <td> <p>20.3</p> </td> </tr> <tr> <td> <p>Seagate</p> </td> <td> <p>5.1%</p> </td> <td> <p>4.7</p> </td> <td> <p>3.4</p> </td> </tr> <tr> <td> <p>JPMorgan</p> </td> <td> <p>2.9%</p> </td> <td> <p>7.6</p> </td> <td> <p>8.6</p> </td> </tr> </tbody> </table>

*Data from Yahoo! Finance

Healthcare

ObamaCare will not be repealed.  Thus, healthcare companies are an attractive area.  In healthcare, three blue-chips stand out: Pfizer (NYSE: PFE), Johnson & Johnson (NYSE: JNJ), and Merck (NYSE: MRK)

Pfizer’s portfolio of cash cows should continue to keep its dividend strong.  However, beware a few risks for the drug giant:

Pfizer has begun to layoff its primary-care sales representatives in order to cut costs. This year, the drug manufacturer’s revenue contracted significantly because of patent expirations of several key drugs, and therefore the company has been forced to offset losses by employing a smaller sales force.

To hedge against revenue hits, Pfizer is laying off workers, something that is happening across the industry.  One reason is likely due to the expiration of the patent for Lipitor, a cholesterol-lowering drug.  This cash cow produced 14% ($9.6 billion) in sales in 2011. 

Also, JNJ and Merck provide solid dividend payouts.  JNJ is backed by brands like Neutrogena, Tylenol, Zyrtec, Splenda, and Motrin, among others.  Stable consumer brands offer consistent earnings.  Also, Merck is in a nice position.  Its international businesses hedge it against a slowdown in a single nation.  Its products cover a wide range of consumer and commercial purposes, ranging from adolescent treatment, to obesity and cardiovascular treatment in adults, to treating various animals. 

Technology

I like Seagate (NASDAQ: STX) because, as more data enters the cloud, large companies have an increased appetite for storage.  Seagate makes hard disk storage for servers, laptops, video recorders, personal storage devices, and numerous other devices. 

Aside from its strong business, the company has a 34% operating margin (ttm) that supports the 5.1% annual dividend payout.

Financials

Jamie Dimon is one of the best CEOs on Wall Street, which is why I like JPMorgan (NYSE: JPM).  JPMorgan was one of the few banks able to emerge in a strong position from the credit crunch, and it demonstrated this by buying up other banks to expand.  Even at $40, JPMorgan has strong upside and room to increase its payout. 

One risk, however – new complex regulations could hamper banks' abilities to profit in the next couple of years.

Conclusion

As investors look to various instruments to increase yield, remember that even “safe” investments like bonds carry risk, especially when interest rates and inflation increase.  Dividend stocks like the ones above have downside, but the opportunity for both income and price appreciation is a strong proposition.


ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson and JPMorgan Chase & Co. Motley Fool newsletter services recommend Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus