Don’t Look To Bonds For Yield — Buy These 3 Stocks Instead
The king is dead. Long live the king. That cheer seems appropriate in context to the recent commotion of Pimco’s fixed-income guru, Bill Gross, jumping ship for mutual fund competitor Janus Capital Group, Inc. (NYSE: JNS).
While Gross’ move may represent the end of an era in the mutual fund business, more importantly it represents what many pundits have been warning about for quite a while: the official end of the bull market in bonds.
As I’ve mentioned in previous writings, I am the furthest thing from a chartist; however, this 25-year study of the yield on the 10-year U.S. Treasury really piqued my interest.
Is the decades long bond rally over? Probably so. But don’t expect rates to rocket any time soon for many reasons. If this chart is any indication, then yields could be forming a double bottom, revisiting their record lows.
So, if rates are poised to go lower, would that imply that bond prices could trend higher? Would the bond market really have any gas left in the tank? I would have to say: No.
Gross’ exit isn’t the harbinger of the bond bull’s death, it’s a consequence. The Bond King was trying to steer his battleship of a fund, the Pimco Total Return Bond Fund (Nasdaq: PTTAX).
Don’t get me wrong, Bill Gross is a smart guy; however, he used decades of easy monetary policy from the Fed and other global central banks to surf the wave of falling yields and rising bond prices to deliver outstanding results for his clients.
#-ad_banner-#Then, as the Fed began to tightening the spigot, he’s wiped out on the reef that every rock star mutual fund manager fears most: poor performance.
So does this mean that bonds represent a clear and present danger for investors? Yes and no. Pouring new money into fixed income isn’t a great idea — not because of the risk of bond prices plummeting overnight, but due to the simple fact that you just don’t get paid that much to hold them.
Throughout my career, I have used higher dividend yield stocks of companies with strong franchises and solid cash flow as what I like to call “bond proxies.” Sometimes, these stocks may have some correlation to the movement of bonds and interest rates. However, their ability to grow their income streams both internally as businesses and what they pay out to shareholders make holding them a viable alternative to bonds.
TECO Energy, Inc. (NYSE: TE)
With its roots as the old Tampa Electric Company, this name has always been one of my go-to utility stocks. Historically, it has traded at a slight discount to its peer group (regulated utilities) and carried a slightly higher dividend yield. Covering more than one million electric and gas customers over one of the most densely populated areas of central Florida, the lion’s share, 68%, of the company’s business comes from the regulated electric space. 17% comes from its coal mining operations, with the remaining contribution from its gas utility.
Gas is where the growth potential lies. Last year, TECO announced plans to purchase New Mexico Gas Company for $750 million adding another half million customers to its regulated utility business. Shares trade at around $17.50, a 5% discount to their 52-week high, and pay a 5% dividend yield, which the company grew at a 2% average annual rate over the last five years. In comparison, treasury yields have declined an average of 5% for the same time period. It’s all about growth of income.
Verizon Communications, Inc. (NYSE: VZ)
If the nation’s largest wireless provider was a Japanese movie monster, its name would be “Cashflowzilla.” Based on 2013 numbers, the company is throwing off $9.78 per share in cash flow. That’s nearly 20% of the $50 stock price. How? In February of this year, Verizon bought Vodafone’s 45% stake in the company for $130 billion. This freed up a significant amount of annual cash formerly used to pay the dividend owed to Vodafone.
On average, VZ’s common dividend has been growing at a decent 2.5% annual rate over the last five years, arriving at 4.5% currently. This was made possible thanks to stellar five-year average annual earnings per share growth of 42%: from $1.29 in 2009 to $4.00 last year. Management is committed to focusing on network upgrades (the key to staying competitive in the wireless space), paying the dividend and reducing debt, which sits at 47.5% to market cap — significant but relatively tame for a telecom company.
Blackstone Group, LP (NYSE: BX)
There’s always been a soft spot in my heart for asset manager stocks. I guess part of the reason is that I know the sausage making process first hand. But the main reason is, if the firm is worth their salt, then there is a clockwork predictability of their revenue streams.
Blackstone has swiftly moved to the top tier of my favorites list. With over $260 billion in assets under management, Blackstone has driven revenue at an amazing 57% average annual growth rate to $6.6 billion last year from $1.7 billion in 2009. Earnings per share over the last three years have climbed to a forecasted $3.25 for 2014 from just $.41 in 2012 — an annual average of 230%. The company achieves this by being damn good at what they do in a highly specialized space, splitting its business into five segments: private equity, real estate, hedge fund solutions, credit lending and financial advisory.
One solid benefit of holding Blackstone, besides expert management and a growing business, is the steady return with a low correlation to stock and bond markets. As most of Blackstone’s investments tilt toward private equity, real estate and loans, investors should experience a little less volatility than traditional stock and bond investments. Shares look darn cheap at $30 with a forward price-to-earnings ratio of 7.7 and an attractive 7.1% dividend yield.
Risks to consider: Although these stocks provide more income and less risk of bond price related volatility, TECO and Blackstone, due to one being a utility (historical heavy reliance on debt financing) and the other a financial company, both are not immune to volatility caused by a falling bond market. The best defense both have is the ability to grow revenue thereby strengthening the income stream paid to investors; something a bond is completely incapable of doing.
Verizon’s obvious risk is slowing business due to technological stagnation. Thanks to the company’s dominant market footprint, it exerts considerable leverage over its handset suppliers, pushing them to innovate.
Action to take –> The days of bond managers like Bill Gross being able to stand in front of a fat, low interest rate pitch and knock it out are probably done. However, that doesn’t necessarily mean that bond prices are about to fall out of bed while yields spike. There are just better ideas out there to provide stable and growing income with the potential of some upside. As a basket, these stocks have an average forward PE of 13 with an attractive, blended dividend yield of 5% — over twice that of a 10-year Treasury. As all three are capable of consistently delivering solid earnings and revenue to fuel income increases, a 12-to-18 month total return — capital appreciation plus dividends — of 28% or better seems reasonable. I just don’t think that type of number is possible with a bond.
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