I thought it was fascinating, a perfect accompaniment to scrambled eggs seasoned with an East Asian hot sauce. If my eggs could pack such a sizzle, I thought, then surely so could these stocks. And so I decided to delve deeper.
It turns out there are 53 stocks in the S&P 500 with dividend yields of 4% or greater. I pick that level because forward inflation, based on the 5-year Treasury note and TIPS yields, is running at 2.07%. So a 4% yield gives me 2 percentage points in real income, or $20 per $1,000 invested.
Not terribly shabby, but certainly not something to write home about. I can get 4% pretty easily in municipal bonds from my home state, Oregon, and they're tax free and will eventually return every dime invested. Compared to that, the S&P 500 high-yielders don't seem so attractive, with a 15% federal tax if held for more than a year and no guarantee that principal will ever be returned.
So, clearly, the only reason to consider high-yield S&P 500 stocks is that I think they are likely to give me capital gains to supplement the dividends. To me, that says growth stocks.
My financial criteria for growth stocks are stringent: A return on equity of 20% or more, showing that management has its act together and knows how to make money, and a debt equal to no more than 10% of equity -- that is, a debt/equity ratio of 0.1 -- since I know from hard and bitter experience how crippling debt payments can be to cashflow.
And, as a nice addition, I also like having a fairly high level of institutional ownership, say 70% or better.
Applying those criteria, and the list of 53 candidate stocks shrinks to -- well, one: PayChex Inc. (PAYX), with a return on equity of 35% and a debt/equity ratio of zero.
True, it's a bit lagging in institutional ownership, at 63%.
Debt/equity proved to be the major limiting factor. Most of these guys know how to make money, with good return on equity, but they go in hock to do it.
The next highest debt/equity ratio was Microchip Technology Inc. (MCHP), with debt equal to 20% of equity, and a 20% return on equity. Also, huge institional ownership at 109% (No, I don't understand it either).
I've had PAYX on my Watchlist for awhile, as an earnings play, and I think it will stay afterward in the Other Bull Plays section.
But this whole exercise does raise some questions: Are my growth stock criteria unrealistically high? Should growth stock expectations be applied to high-yield dividend plays?
These questions are important, because my conclusions in this study put me at odds with the Dow Theory folks, who are very smart and have been doing successful market analysis since my great-grandpa's day. Compared to them, I'm a just a Timmy-Come-Lately.
Mind you, I don't have answers yet. The questions are pretty interesting, though.
Click below for PAYX in the ...
- ... most recent daily Watchlist.
- ... most recent Weeklies posting.
Disclaimer
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.
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