Bond Risks Point to Stock Preference

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

“Every one of the most popular class of US mutual funds investing in bonds lost money in May, highlighting the risks for investors as interest rates rise,” according to The Financial Times. With bond risks elevated, stocks are the more attractive option. Consider companies like Royal Dutch Shell (NYSE: RDS-B), Altria (NYSE: MO), and Southern Company (NYSE: SO).

A problem inversion

Bond prices move in the opposite direction of yields. So, as interest rates have moved toward historic lows, bond prices have moved to all-time highs. However, with rates at historic lows, there isn't much further for rates to fall. That means rates are more likely to head higher than lower, with bond prices falling in response.

That makes now a historically risky time to start buying bonds. At the end of the day, investors would likely be better served owning stocks over the long haul than bonds at this point of time despite elevated stock prices.

Demand and yield

One option to consider is Royal Dutch Shell. The company is one of the largest integrated oil companies in the world. It sells commodities that are necessities, used every day, and sold across a huge customer base.

Shell has had a couple of negatives restraining its shares of late. The first is the move it made into U.S. natural gas when prices were high. With U.S. natural gas prices near historic lows because of oversupply, the investment looks like a poor one. However, Shell expects natural gas demand to increase over the next decade or so. The start of that trend has already begun, with electric utilities shifting generation toward gas. When, not if, gas prices recover, this drag will turn into an asset.

The second issue is Shell's search for new reserves. This is a problem across the industry, since the easy oil has been found. So, Shell has begun to look for oil and gas in harder to reach locals. It ran into trouble in the Arctic recently and halted its efforts after a ship ran aground in a storm. No oil was spilled, but it was a reminder of the risks.

Although the top and bottom lines can vary greatly from year to year, the company has a long history of regular, though not annual, dividend increases. The yield was recently around 5%, which is better than what many bonds offer. This is probably the best option in the oil patch right now.

Some smokes

Another stock to consider is Altria. The company is the largest tobacco company in the United States and owns the iconic Marlboro brand. Although the company spun off its foreign operations, which effectively removed any hope of notable business growth, the U.S. tobacco market is highly regulated.

That regulation effectively protects Altria's market share since it is nearly impossible for new players to enter the market. So, the company is the 800-pound gorilla today and will likely remain the big player for a long time. Since the spin off of the foreign operations, Altria has managed to return value to shareholders via stock buy backs and dividends. It offers a yield of around 4.90%.

The U.S. tobacco market is shrinking, which is a notable long-term risk. However, customers are generally willing to pay increasing prices for the mildly addictive product. Price hikes have generally been offsetting unit sales declines. That trend should continue. Moreover, Altria has been working on growing its smokeless business, which is an increasingly important niche.

In other words, Altria is far from a dying company. If you can handle owning a sin stock, Altria is a solid option with a long history of regular annual dividend increases.

Electricity

Southern Company is one of the country's largest electric utilities. Although it has a small merchant power business, it earns that vast majority of its revenue from its regulated operations in Florida, Georgia, Mississippi, and Alabama. It is one of the most widely held utility stocks in the country.

Southern has increased its dividend annually for twelve years. The recent yield was around 4.60% after an industry wide sell off. That's a compelling yield, though patient investors might want to wait until the shares yield over 5%.

Being a big utility, however, is only part of the benefit here. The company has generally good relationships with its regulators and operates in growing markets. Thus, organic growth is likely to lead to slow, but steady, top and bottom line advances. However, the company is also building two big power plants, one a nuclear facility and the other a coal gasification plant. Not only will these plants help keep fuel costs down, but they should help Southern win rate increases.

Nothing is risk free

Bonds today are a lot more risky than many fully understand. Buying into great companies offering bond-like yields is a good alternative. Shell, Altria, and Southern all offer such yields and have solid businesses. If the market heads south, these stocks may fall, but the underlying businesses should allow for continued dividend hikes.

Altria has been the best-performing stock of the past 50 years, but as the number of smokers in the U.S. continues to steadily decline, is Altria still a buy today? To find out whether everyone’s love-to-hate dividend stock is a savvy investment choice or a hazard to your portfolio, simply click here now for access to The Motley Fool's premium research report on the company.


Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Southern Company. 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!

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