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June, 2010

THE HIGHER YIELD, LOWER PAYOUT ADVANTAGE
by LARRY

Money market funds, short-term bonds, Certificates of Deposit (CDs), and other traditional sources of income are now offering interest of only about 2% or less and sometimes also come with extra risk, for when the Central Bank begins raising the discount rate, as is widely expected within the next 12 months, bond principals will go down.

Folks who need a good income stream, then, may be looking elsewhere to have regular investment additions to their budgets. An annuity may be one option, but often one sacrifices some of a nest egg for the boon of guaranteed checks coming through an insurance company or other annuity manager.



A relatively low risk alternative, that can better preserve one's own wealth, may be to invest in higher yielding stocks with low dividend payouts.

In a 26-year study by Credit Suisse, from January, 1980, to June, 2006, it was found that higher yielding stocks, which also had low dividend payout ratios, on average provided total annual returns of better than 19%. Studies have also shown that higher yield lower payout stocks are less risky in market downturns than either higher yielding but higher payout stocks or the major indexes.

As the terms suggest, high dividend payout companies use more of their available earnings on their dividends to shareholders, leaving them lower balances for research and development, expansion, or dealing with the business consequences of recessions or increased competition. They are, in general, more likely, then, to find such policies unsustainable and so have to subsequently cut their dividends. Such stocks are particularly vulnerable to losses.



It has been noted that, by contrast, higher yield, but lower dividend payout stocks generally decrease in value less during volatile periods, only about half as much in bear markets, as the major indexes. They may thus be used to lower a nest egg's overall risk while also providing valuable income.

A sample of such stocks, with reasonably good dividends and relatively low payout ratios, is included in the table.

CompanySymbolRecent
Price
DividendDiv.
Payout
Ratio
Chevron Corp.CVX$75.523.9%41%
Ennis, Inc.EBF$15.784.0%34%
Ensco plcESV$40.823.7%2%
Johnson & JohnsonJNJ$59.183.7%41%
Mattel, Inc.MAT$22.503.5%45%
Merck & Co., Inc.MRK$35.674.4%30%
National Healthcare Corp.NHC$35.313.3%44%
WD-40 CompanyWDFC$33.403.1%48%


No guarantee of past superior total returns can be offered for the future performance of the eight cited stocks. However, they do all appear to have characteristics in their favor that may give them, as a group, an edge in competition with the average lower dividend and/or higher payout stocks of, for instance, S&P 500, NASDAQ, or Russell 2000 equities.

Primary source: High Yield, Low Payout. Panka N. Patel, Souheang Yao, and Heath Barefoot in Credit Suisse Quantitative Equity Research; August 15, 2006, pages 30-32.



DISCLAIMER

Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)



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