Word of progress in ceasefire talks between Russian and Ukrainian negotiators in Turkey on March 29 led to a positive reaction among investors. But even an immediate end to the hostilities wouldn’t change the fact that the U.S. is in a cycle of rising interest rates as the Federal Reserve fights high inflation.
In a report on March 29, analysts at Jefferies wrote that receiving dividends “should become an entrenched theme” in the stock market. Growth-oriented strategies, they noted, are likely to suffer under the Fed’s tightening cycle.
Below is a screen of value stocks with high dividend yields that are well-supported by expected cash flow.
The bond market’s recession signal
Investors and analysts are growing more concerned that the inverted yield curve for U.S. Treasury securities is pointing to a recession and possibly even stagflation — a combination of high inflation and shrinking demand. Focusing on value stocks with high dividend yields might help you make the most of what could be a difficult environment over the next two years.
First, take a look at Treasury yields at the end of business on March 28 for various maturities:
You can click on the maturities in the left column to go directly to that Treasury security’s quote page.
Yields on three-year
Treasury notes were higher than the yields on 10-year notes
and 30-year bonds
This type of inverted yield curve has pointed to previous recessions. However in a report on March 29, analysts at BCA Research led by Ryan Swift expressed nuanced opinions based on the movement of interest rates before previous recessions:
An inverted Treasury yield curve is a “reliable” recession indicator, especially when (or if) the two-year yield exceeds the 10-year yield. But inversion of three-month to 10-year yields would provide a “more timely” recession signal.
In light of the above, “it is premature to talk about a recession.”
The spread between three-month and two-year yields has actually widened considerably over the past month, which bodes well for banks’ profits, at least until the next recession.
So the timing of the next recession is in question. Getting back to the value/dividends theme from the Jefferies analysts, this is a good time to screen for both.
A value/dividends stock screen
The Russell 1000 index
is made up of the largest 1,000 U.S. stocks by market capitalization, which represent about 90% of the U.S. equity market. One subset is the Russell 1000 Value Index
which comprises about 850 stocks of companies in the Russell 1000 that have lower price-to-book ratios and lower expected growth rates. You can read FTSE Russell’s descriptions of the makeup and scoring for its indexes here.
Within the Russell 1000 Value Index, there are 25 companies whose stocks have dividend yields of at least 5.00% and for which free cash flow estimates or similar data are available.
A company’s free cash flow is its remaining cash flow after capital expenditures. It is money that can be used to pay dividends or to expand, make acquisitions, repurchase shares or for other corporate purposes. If we divide a company’s expected annual free cash flow per share by the current share price, we have an estimated free cash flow yield, which can be compared to the current yield to see if there is “headroom” for higher dividends.
Headroom indicates there is at least good support for the current dividend payout. Dividend cuts are best avoided, as they can cause share prices to decline dramatically.
For some companies, free-cash-flow estimates aren’t available. Among those, we can use consensus estimates for funds from operations (FFO) for real estate investment trusts. FFO is a non-GAAP measure that is considered in the REIT industry to be a good gauge for dividend-paying ability. It adds depreciation and amortization back to earnings, while excluding gains on the sale of property. So for REITs the headroom estimates are based on FFO.
For most companies in the financial sector, free cash flow figures aren’t available. For these, we have used consensus earnings-per-share estimates for headroom estimates, as EPS is used by regulators to set caps on dividend payments for the largest banks.
In addition to screening for dividend-paying headroom, we also excluded from the list any company that cut its regular dividend over the past five years.
Here are the highest-yielding stocks that passed the screen, sorted by dividend yield:
Estimated 2022 FCF yield
Estimated 2022 “headroom”
UWM Holdings Corp. Class A
Omega Healthcare Investors Inc.
Real Estate Investment Trusts
OneMain Holdings Inc.
Devon Energy Corp.
Oil & Gas Production
New York Community Bancorp Inc.
Kinder Morgan Inc Class P
Oil & Gas Pipelines
Medical Properties Trust Inc.
Real-estate investment Trusts
Lazard Ltd Class A
Oil & Gas Pipelines
Store Capital Corp.
Real-estate investment Trusts
Click on the tickers for more about each company.
Then read Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.
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