News Analysis date published New: 
Friday, October 26, 2012 - 14:30
New Date created: 
Friday, October 26, 2012 - 15:28
New Date last updated: 
Friday, October 26, 2012 - 14:30

Bull vs. Bear: Should You Buy the Highest-Yielding Stock in the S&P 500?

Friday, October 26, 2012 - 2:30pm

Editor's Note: Here at StreetAuthority, we've been talking about the best way to build a retirement portfolio. Simply put, our conclusion is that, regardless of what stage of life you're in, the best way to do this is with what we call Retirement Savings Stocks. So does the highest-yielding stock in the S&P 500 fit the bill? Here we offer two opinions and leave it up to you to decide.

Buy it Now, Get Paid to Wait...

By: Adam Fischbaum

Readers of my articles should know I'm a huge fan of postage meter giant Pitney Bowes (NYSE: PBI). But I'll admit that I'm probably in the minority on this.

Am I throwing in the towel? Not quite yet.

While Pitney Bowes has the dubious distinction of having the highest dividend yield in the S&P 500, many investors warn of the stock's potential to become a "value trap." But the way I see it, the stock provides investors with a chance of getting overpaid while they wait for an exciting story to pan out. After all, a broken clock is right at least twice a day.

But before I tell you about this great story that's waiting to happen, let's get some not-so-exciting news out of the way…

The company reported second-quarter revenue of $1.2 billion, down nearly 5% from the same period last year. The stock is currently 34% off its 52-week high. In addition, performance is weak in the company's core mailing services and equipment segments. Pitney's nearly 11% dividend yield means that its dividend payout ratio -- a good measure of a company's financial stability -- has skyrocketed past the comfortable 50% level. This is why some investors are saying the stock is a value trap waiting to happen, as noted before.

But here's the other side to this story.

Not so much of a trap…
Last year, capital expenditures (the company is reinvesting in itself to promote growth) were up 30% year-over-year, totaling $156 million. During the second quarter, the company was able to reduce its debt by $578 million after knocking down $150 million in the first-quarter. Free cash flow jumped an eye-popping 43% during the second quarter to $301 million in comparison with the same period the year before. Throw in 30 years of consecutive dividend increases... Do you see this as a value trap? I don't.

The fact is people are still going to send "snail mail" in the future, since some things just can't travel electronically. So even though the market for this product will unequivocally shrink, Pitney Bowes will still own the lion's share of the industry.

But Pitney still needs to grow its business, and in this sense, Volly should be a huge help. Volly is Pitney's cloud-based, e-financial platform designed for small- and medium-sized businesses. It's been thoughtfully and inexpensively developed, so the profit margin is bigger.

Pitney is also in the early stages of a multi-year partnership supplying geocoding and location-intelligence apps to social media giant Facebook (NYSE: FB). If you've ever posted your location on Facebook, then chances are you've used Pitney's technology.

But even if management has to cut the dividend as one of its cost-cutting measures, it might not be so bad. A reduction of the dividend's $1.50 per share payout to 75 cents per share, based on a $14 per share price, would still equate to a yield of about 5.5%. This isn't bad for a stock that trades with a forward price-to-earnings (P/E) ratio of 7.

Risks to Consider: It's true that The U.S. economy, while seemingly healing, could tank again. And if this happens, then Pitney Bowes would have to implement harsh cost-cutting measures. After all, about 70% of the company's revenue comes from the United States.

Action to Take --> I'm sticking to my guns on Pitney Bowes. Sure, I'm concerned with the poor performance of the stock. But I'm not convinced the fundamentals are deteriorating to the point where it's time to pull the plug. If anything, they're slowly but steadily improving. In fact, management and analysts have guided that revenue and earnings should remain steady in the near term.

This means there is plenty of room for an easy-to-reach upside surprise. With this catalyst in mind, a 12-month price target for the stock of $27 per share makes sense based on upside earnings potential, creating a forward P/E expansion of just 27%. This would translate into a 93% gain for the stock. If the dividend holds steady, then the total return would be more than 100%.

Avoid this Stock at all Costs

By: Jay Peroni

Sometimes, chasing after that double-digit yield isn't the best way to build a long-term investment worthy for your retirement years.

If you're looking for a safe income stream, then you want to own stocks that steadily pay solid dividends that consistently rise over time. These are stocks from companies you don't have to worry about whether they'll be in business 10 years from now. We at StreetAuthority call these Retirement Savings Stocks.

I am always on the hunt for the best retirement stocks for my clients. I love stocks that offer fat dividends yields and have strong capital gains potential. So naturally, my attention was quickly drawn to Pitney Bowes (NYSE: PBI), a stock that pays a hefty 10.5% dividend yield -- the highest in the S&P 500. But the stock didn't catch my attention because it's a great Retirement Savings Stock. Instead, this seemingly no-frills income stock should be avoided at all costs.

Here's why...

Pitney Bowes was founded more than 90 years ago and has grown to become the largest global provider of mailstream solutions. Its core equipment business has expanded from postage-metering machines to more complex mail sorting, inserting and production equipment. The company also provides outsourced mailroom and document management to enterprise customers. Recent additions to the company's product portfolio include digital mail delivery, customer relationship management, data analytics, location intelligence and other software platforms.

This all sounds interesting, but the problem is the mail business is dying. And a quick look at its price chart told me everything what I needed to know...

Too late to adapt
In its heyday, Pitney Bowes had an economic moat that separated it from competitors in the direct-mailing business. It enjoyed being an approved vendor of the highly-regulated U.S. Postal Service, but a major decline in demand for mailing services has forced Pitney to adapt into a new breed of company.

So as clients started to look into similar priced alternatives such as Constant Contact (Nasdaq: CTCT) for direct email marketing, Google (Nasdaq: GOOG) AdWords for promotional campaigns, PayPal (Nasdaq: EBAY) for invoicing or Stamps.com (Nasdaq: STMP) for occasional postage, Pitney began investing in technology through acquisitions and product development. Its attempts to go digital have also been lackluster.

The company has been heavily investing in capital equipment products with software platforms in an effort to increase equipment sales. But this strategy appears to be failing as Pitney's software segment margins have declined for five straight years, including a 11% drop in the past year alone. In 2008, software earnings before interest and taxes (EBIT) were $55 million. By 2011, this number had dropped to $38 million.

Overall, Pitney is not in terrible financial shape. But Pitney's future -- especially its dividend -- indeed appears quite uncertain. Strong cash flow has allowed it to pay a rich dividend, but if its recurring revenue streams continue to degrade, then the dividend could weaken over time.

Action to Take --> If you're trying to build a safe retirement portfolio, then stay away from Pitney Bowes. I don't believe the company will ever return to its historical levels even as the economy recovers. The direct mail marketing industry has steadily declined even prior to the economic downturn, and this trend will not reverse.

The digital era of marketing and advertising is here to stay. Pitney's failure to cross the digital divide will eventually cannibalize the company's capacity to generate enough cash flow and revenue to sustain its generous dividend.

[Note: Think Pitney Bowes is a great invesment for a Retirement Portfolio? Or is it a dog? Let us know your thoughts by emailing us at editorial@streetauthority.com. And while you're at it, check out our special presentation on Retirement Savings Stocks here.]

Adam Fischbaum, Jay Peroni does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.