All the talk of possible future insolvency in Social Security is masking the bigger problem, that even with SSI benefits current retirees are having a hard time paying for the necessities.
SSI benefits have never really been enough but a portfolio of bonds with some stock exposure for inflation-protection was all it used to take to provide a little extra income and capital preservation. Income returns above five percent were more than enough to fund living expenses beyond other sources.
Now, the need for safe income has run face-first into the Fed’s ultra-low rate environment and many are having trouble living off of the fixed income their bonds provide. While yields have come up this year, the 10-year Treasury still only pays 2.76% and corporate bonds are not much better at just 3.5% for AAA-rated debt. At that return, many will see their savings disappear in as little as 10 years.
There’s safety in stocks as well, you just need to know where to look. As a result, many have piled into higher-yield bonds like non-investment grade and emerging markets. The problem is, there’s a reason why they’re called junk bonds, because the company’s finances may not be as safe as you think.
Before you rush to the relative yield of junk bonds or emerging markets, take a look at shares of companies with a strong business model and relatively low volatility. Looking for companies with safe income, I like low-beta names that have high yields and relatively safe streams of income. Beta is the measure of risk compared to the general market. A stock with a beta of 1.0 is about as risky as the market, while a beta less than that is relatively safer. Besides this, make sure you select stocks from a mix of sectors so you don’t leave yourself exposed to industry- or sector-specific risks.
Lorillard (LO) is a $16 billion distributor of cigarettes and e-cigarettes in the United States. I don’t smoke and agree that it is harmful to you health, but I can’t deny the strength in the business model. While there will always be the threat of legislation or litigation, the business is a cash machine and the progress into safer e-cigarettes helps to offset some of the risk for Lorillard.
The company has a beta of just 0.27 and pays a 5.1% dividend yield. The shares trade for 13.4 times trailing earnings with net income expected to rise 11% in fiscal 2013 versus last year.
Merck & Company (MRK)
Merck & Company (MRK) is one of the largest pharmaceutical companies in the world with a market capitalization of $137 billion. The company is diversified across a range of solutions including prescription medicines, vaccines, biologic therapies, animal health and consumer care. For many retirees facing the mounting pressure of high medical bills, Merck is a great investment to get something back.
The company has a beta of 0.50 and pays a 3.6% dividend yield. The shares trade for 13.5 times trailing earnings though net income is expected to come down almost 9% this year to $3.49 per share. Earnings are projected to rebound next year and the company should have no problem maintaining its dividend.
Sysco Corporation (SYY)
How many times have you been searching for news on Cisco (CSCO) and instead come across Sysco Corporation (SYY)? Hopefully, you looked further into the company and saw it for the ultra-safe, cash machine that it is. The $18.7 billion food service company markets and distributes products to cafeterias, hospitals and restaurants across the United States, Canada and Ireland. The company is a leader in its industry and carries an established record.
The company has a beta of 0.69 and pays a 3.5% dividend yield. Shares are down sharply since the last quarterly report but earnings are expected to rebound 10% next year and revenue growth has been stable. The shares trade for 17.3 times trailing earnings, relatively expensive but with a stable outlook.
PPL Corporation (PPL)
A diversified list of safe, dividend-payers would not be complete without a selection from the utilities. PPL Corporation (PPL) is a $ billion energy and utility holding company with retail customers in Pennsylvania, Kentucky, Virginia, Tennessee and the United Kingdom. The company just won higher rate increases in Kentucky and Pennsylvania, which should support revenue this year against lower margins.
The company has a beta of just 0.14 and pays a 4.8% dividend yield. The shares trade for 12.4 times trailing earnings and have been under pressure lately for the accelerated recognition of convertible securities which will dilute existing shareholders.
Outperforming on a risk-adjusted basis
While the average gain over the last year for an equal-weight portfolio of the four stocks is 10% versus an 18% rise for the stocks in the S&P500, adjusting for dividends and splits, the risk-adjusted performance yields another picture. The average beta for the stocks is just 0.40, less than half the volatility of the general market. Further, the average yield for the four stocks of 4.25% is more than double the 1.98% paid by those in the S&P500.
For those seeking stable income and relatively safe capital, make sure you fill your portfolio with a basket of sectors and stocks. Beat the effect of a low-rate environment by selecting stocks with stable business models, compelling valuation and low volatility relative to the market.