This article is Part 3 of a series of articles focusing on finding value in the S&P 500 today. In Part 1, we laid out several classifications of equities that comprise the S&P 500. In our follow-ups we are focusing on each of these classifications one at a time, in order to focus on finding fair valuation within each category. There’s a lot of discussion, much of it suggesting that stocks are overvalued today. We disagree, because we conducted a thorough examination of each of the S&P 500 constituents, we did indeed find a lot of value in this market. Here is a link to Part 1, where we laid out our thesis of a market of stocks rather than the stock market, and identified the categories that we are writing about in these subsequent articles.
In Part 2 we focus exclusively on high-growth stocks that are constituents of the S&P 500 and we believed were fairly valued today.
In this part 3, we turn our attention to the highest yielding stocks that are constituents on the S&P 500. However, we submit that there are essentially two primary reasons that explain why these stocks offer such high yields. The most prominent is that these are low growth entities that need to offer high dividend yields in order to attract investors. The next most prominent reason is that some of these entities have seen their stock prices collapse because of fundamental issues and challenges within their respective business models. Consequently, their high yields could be either a temporary illusion that will soon change, or perhaps indicative of high risk.
Therefore, we submit that the moral of this story is that everything is not all that it often appears to be. High yield is nice, but if it also implies high risk, the investor has to be prepared to factor that into their decision-making process. In other words, the prospective investor has to decide whether or not the reward is worth the risk taken to achieve it.
We have identified 17 companies in the S&P 500 that offer a yield of 5% or greater. We then broke this down into two sets, one that we felt had higher risk, and one that we felt represents good opportunities for the investor either seeking high yield, or high yield plus growth. It is very important to state that this is a prescreened list based solely on organizing the S&P 500 by order of highest dividend yield to the lowest utilizing the F.A.S.T. Graphs™ fundamental analyzer software tool. Then we ran individual earnings and price correlated graphs on each of our 17 selections in order to sort them by risk.
More importantly, the reader should understand that we are not recommending any of these selections. Nor are we suggesting that any of these selections should be avoided. Instead, we are offering both lists for the sole purpose of providing the reader with a selection of S&P 500 high yielding constituents that may be worthy of further due diligence and research. On the other hand, we hope that the reader finds it useful to have both lists sorted by apparent risk, based on fundamentals.
High Risk-High Yield S&P 500 Constituents
We do not believe it is a coincidence that our high-risk list contains most of the highest yielding S&P 500 (INDEX.INX) constituents. In today’s interest rate environment, the prudent investor needs to proceed with caution when they see yields that are significantly higher than the current environment generally is offering. On the other hand, given that the market can often improperly appraise the price of a stock, an aberrantly high-yielding security should not be immediately rejected either. There is always the possibility that a more comprehensive research effort may uncover a great long-term opportunity.
The following table lists nine high yielding S&P 500 (INDEX.INX) constituents that we believe should be carefully evaluated and scrutinized. With many of the selections, further examination will show that there are current issues with the companies’ profitability. In other words, some of the selections are experiencing deteriorating earnings for one various reason or another. Consequently, dividend cuts or even price erosion should be considered as real possibilities. In other cases, there are valuation issues, or more precisely, overvaluation issues that need to be evaluated. Later we will provide a more detailed example of both for illustration purposes.
Windstream Corporation (NASDAQ:WIN)
Our first example reveals a telecommunications company that has experienced a lot of earnings pressure.
Windstream Corp. provides high-speed broadband Internet, phone service and Digital TV packages to residential customers as well as products and services for small, medium and large businesses, and government agencies. Windstream Corporation (NASDAQ:WIN) was formed from the spinoff of Alltel Corporation’s landline business and merger with VALOR Communications Group, Inc.
As can be clearly seen from the following earnings and price correlated F.A.S.T. Graphs™, due to the challenges of its legacy wire line business, Windstream Corporation (NASDAQ:WIN) has experienced a steady erosion of its earnings. Consequently, we believe that the risk of a dividend cut is high, and therefore, investors should be cautioned not to be too enamored with its high yield.
As you review the performance of Windstream, there are two important concerns that need to be considered. First, note that as earnings have eroded, so has the principal value. Second, the current high payout ratio should serve as a red flag warning about the viability of its dividend long-term.
Health Care REIT, Inc. (NYSE:HCN)
Health Care REIT, Inc. (NYSE:HCN) is a real estate investment trust that has been at the forefront of senior living and health care real estate since the company was founded in 1970. Since REITs are primarily based on their ability to generate dividends, the reader should note that the following F.A.S.T. Graphs™represents a Funds From Operations (FFO) and price correlated graph instead of earnings and price.
Consequently, what we see here is a very stable REIT; however, history also shows that there hasn’t been a lot of growth. But most importantly, the reader should notice that the company is currently trading at the highest valuation relative to Funds From Operations (FFO), its normal price to FFO, and its cash flow capability (the light purple line).
There is another good way to assess the current valuation of a REIT by evaluating its current dividend yield relative to historical norms. In other words, if Health Care REIT, Inc. (NYSE:HCN) was trading at a more historically normal valuation, its current yield would be higher than the 5% it currently offers. All this suggests is that today’s moderate overvaluation may limit both the total income and capital appreciation potential that the risk of owning this REIT would justify.
Moderate to Low Risk High Yield S&P 500 Constituents
Our second list of high yield S&P 500 (INDEX.INX) constituents appear to offer their yields at lower levels of risk than our first list. However, the reader should be cautioned that it is only based on a prescreened review of the earnings and price correlation. Therefore, it is also possible that some of the companies on this list may also be of higher risk than many investors