News Analysis date published New: 
Monday, May 6, 2013 - 11:30
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Monday, May 6, 2013 - 14:54
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Monday, May 6, 2013 - 11:30

High-Yield Tips, Picks... And A Favorite Yielding 6%

Monday, May 06, 2013 11:30 AM

I hope you were able to join me earlier this week on my telephone interview with StreetAuthority Stock Market Strategist Elliott Gue and a few thousand of his closest friends.

During the hour-long conference call Tuesday, Elliott disclosed some of his favorite income stocks and investing strategies (more on that below).

But the revelation I've been thinking about the most the past few days came not from Elliott, but from the audience.

Allow me to explain...

The technology we used on the telephone conference allowed me to survey listeners during the call itself and receive instant results. (I'm sure many of you have participated in a similar exercise: "On your dial pad, press 'one' for 'yes' or 'two' for 'no.'")

One of the questions I asked the audience on Tuesday was this: "Have you ever bought a high-yielder you lived to regret? Press 'one' for yes..."

The virtual switchboard lit up even before I could get to, "Press 'two' for 'no.'" Within seconds, I could see on the computer screen that more than 60% of my listeners had, in fact, been burned by a stock that they purchased primarily on the promise of the big yield it offered.

I'll admit to having been a little surprised -- not to mention unsettled -- by the 60% number. Elliott, on the other hand, has seen it all before.

"One of the biggest mistakes that I see a lot of investors make is that they focus solely on the highest-yielding equities in the U.S. market," Elliott said on the call. "They simply run their finger down the page of The Wall Street Journal looking for stocks yielding 10% or more. The problem is that the highest, most tempting yields are often the riskiest."

The antidote?

"Look for firms with a solid yield AND a history of boosting their payouts over time," said Elliott.

On the conference call, Elliott cited details of a stock screen in which he isolated a group of companies that demonstrated a three-year dividend growth rate, along with prospects for more of the same over the next few years. This basket of stocks returned 619% over the prior decade, trouncing the S&P 500 by a more than 5-to-1 margin.

Elliott's research confirmed that many of the most promising dividend-growers have yields of 5% to 7% rather than 10% or more. Moreover, Elliott found, many of the biggest winners are those stocks that are growing their payouts at a 10%-plus annualized pace.

Another factor Elliott said he watches closely when it comes to selecting a "safe" dividend payer is the payout ratio -- the percentage of profits a company pays out in dividends. When a company needs more than 80% of its profits to pay its dividends, "investors should tread carefully," Elliott said, adding that payouts of more than 100% are unsustainable.

(Don't be fooled again. Click here to learn how you can obtain a copy of Elliott's special report, "Is Your Dividend Safe?" -- four simple rules to help you spot vulnerable dividends. It's part of a subscription package that includes six other bonus reports.)

Elliott also looks at a company's debt levels when assessing dividend safety. "Companies with high debt may have to cut their dividends to pay interest on their loans," Elliott said, while "failure to make debt payments would probably result in default and serious consequences."

But the best tool of all for investors in search of safe, high yields might very well be Elliott's rebranded advisory, High-Yield PRO.

If you haven't heard, Elliott is adding a number of valuable features to the newsletter formerly known as High-Yield International.

For one thing, Elliott will for the first time in this advisory make specific recommendations on U.S. income stocks. These picks will be bought and sold in a portfolio separate from his tried and true international recommendations. All of Elliott's trades going forward will be funded with $200,000 in seed money from StreetAuthority.

Each issue of High-Yield PRO will also include a basic options trade designed to generate even more income. And you won't want to miss Elliott's monthly "Dividend Blacklist" -- a list of companies whose payouts Elliott thinks could be vulnerable to a dividend cut over the next six to 12 months.

For more information on High-Yield PRO, click here.

And for more information from Elliott right now, keep reading...

What follows are some selected quotes from my interview with Elliott this past Tuesday. To read or listen to the full interview, follow this link.

On market conditions worldwide:

Elliott: Global stock markets this year have been very strong. We've seen strength in the U.S. markets, we've seen strength in Europe despite the fact that the region continues to experience a recession, and particularly we've seen a lot of strength out of the Japanese market. In fact, the Nikkei 225 and Topix (which track the performance of Japanese stocks) have been the top-performing major stock market indexes in the world this year.

Generally speaking, I think 2013 is going to be a strong year for global stock markets. The main driver of upside so far has been increasing evidence that the global economy is picking up.

I wouldn't be surprised to see a 5% to 10% pullback in global markets over the next two to three months as investors take some profits off the table. But, this would be an excellent time to buy stocks, and I'm looking to add to the High-Yield PRO portfolios on any dip.

On which sector looks particularly interesting right now:
Elliott: With the global economy perking up, I see more opportunities in cyclical sectors that have lagged.

One example of a cyclical group to watch is energy. With the Chinese economy showing signs of perking up again from a slowdown in 2011 and 2012, demand for oil in China is accelerating. The same is true in other emerging markets like India and Brazil. Growth in oil demand from these fast-growing emerging markets is more than offsetting a modest decline in demand from the developed world, including the European Union and the United States.

Meanwhile, producers outside North America have experienced significant difficulties bringing new sources of supply on-stream. Producers are increasingly targeting fields in deepwater regions and the Arctic, where oil is more difficult and expensive to produce. Growing demand and the need to target more expensive-to-produce fields to grow supply will keep oil prices elevated over the next few years. That's a boon for stocks in the energy industry.

On looking for yields:
Elliott: A few of the things I like to see are steadily increasing dividend payments -- in particular, steadily increasing dividends along with no cuts or missed payments, strong cash flows, strong projected growth and a sustainable payout ratio.

Of course, picking a solid income investment involves a lot more than just running a few screens looking for stocks that meet certain quantitative criteria.

I also spend a great deal of time assessing the big-picture outlook for the economy in the United States and abroad. This analysis can often point me to certain countries or industry groups that look particularly promising.

On ways income investors can limit their tax liability:
Elliott: Investors, retirees and others who depend upon investment income can often shield a substantial portion of their investment income from taxes (whatever their tax bracket) by switching from high-tax investments to some that defer or eliminate taxes entirely.

For example, a number of companies are spinning off divisions as limited partnerships or master limited partnerships (MLPs).

The reason is that income from partnerships like these is not taxed as dividends or interest. A substantial part is legally classified as "return of capital" and therefore is not immediately taxed.

Here's an example: Teekay LNG Partners LP (NYSE: TGP). Teekay owns interests in 29 vessels that transport liquefied natural gas (LNG) and is one of my favorite plays in this segment of the shipping industry.

Now, here's where it gets interesting for investors...

Teekay LNG Partners pays out an annual yield of around 7% -- or between 4 and 11 times what you can get from investing in U.S. Treasury bills.

But, like all MLPs, Teekay LNG Partners estimates that a large proportion of the distributions that investors receive through the end of 2014 will be considered a return of capital by the Internal Revenue Service.

Return of capital payments are not taxable but serve to reduce your cost basis in the partnership, and are taxed only after the partnership units are sold.

That means that a significant portion of your tax liability is deferred each year.

As a result, not only can you, at a bare minimum, quadruple your investment income over what you can earn from U.S. Treasury bills, but you can also potentially defer the tax as well.

Depending upon your situation, this could be a huge advantage. Of course, I recommend that investors consult with a tax professional to determine if investing in MLPs is right for their particular situation.

An investment recommendation:
Elliott: One of my favorite energy recommendations in High-Yield PRO is an Italian firm called Eni (NYSE: E). It's one of the world's largest crude oil and natural gas producers with projects in Africa, Norway, Kazakhstan, the Middle East and the U.S. Gulf of Mexico.

In fact, thanks to some promising new oil and gas finds, Eni will be one of the world's fastest-growing major international energy producers over the next five years -- I see production growing at a more than 4% annualized pace between now and 2016, compared with around 1% to 2% for Exxon Mobil (NYSE: XOM).

The stock also offers a yield of about 6%, more than double Exxon Mobil's 2.9% payout, and trades at 1.05 times its book value compared with nearly 2.4 times for Exxon and 1.7 times for Chevron (NYSE: CVX).

You might be wondering why is Eni so cheap relative to its industry. The answer is that because it's based in Rome, the stock has been pressured by concerns about Europe's economy.

But that's irrelevant: Most of Eni's assets are located outside of Europe, and it produces commodities that are priced in U.S. dollars, not euros. The price of oil has a lot more to do with the state of China's economy than it does with that of Italy's.

On exchange-traded options:
Elliott: For many investors, options are downright scary. The common perception is that options are something traders use to speculate on short-term moves in stocks, commodities and market indexes.

Options can, in fact, be used in that way. However, there are a handful of simple options strategies that actually reduce your overall risk and can be used to generate additional monthly income from stocks you might already own.

One of the simplest and most powerful is what's known as a covered call. A call option is simply a contract that allows the holder to buy a stock at a pre-set price, known as the "strike price," on or before a pre-set expiration date.

To execute a covered call trade you will need clearance from your broker. To obtain that clearance, you'll typically need to fill out a handful of forms online; approval generally takes just a few days. And capital requirements are minimal -- most brokers will let you execute covered calls with as little as $3,000 in your account.

The best news of all about covered calls is that they're easy to execute and among the lowest risk options trades an investor can make.

P.S. -- Every 30 days in High-Yield PRO, Elliott will walk you through at least one options strategy designed to capture yields of 20%-plus on an annualized basis. And that's on top of the regular features in the advisory, which include the best U.S. and international recommendations for the current month. Listen to this Web presentation to learn how you can save 50% off the regular price by taking advantage of a charter subscription to High-Yield PRO (for the text version, click here).

Bob Bogda does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of E, TGP in one or more of its “real money” portfolios.