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Stock Screen: Highest Yielding Stocks with the Best Payout Ratios - November 30, 2012
One of the things investors find most alluring about dividends is that they are real hard cash. They simply can’t be faked and they can’t be taken back. That said, dividend payments can be cut or eliminated if a financially weak company gets into trouble. This can happen for any number of reasons, but for an investor using dividend payments to augment their income, the end result is a pay cut.
There are many ways to examine a company and attempt to determine its ability to continue paying dividends. One quick and easy method is to check a company’s payout ratio. The payout ratio takes dividends and divides such payments by net income, essentially showing the percentage of earnings that is going to cover dividend payments. The lower the percentage the better, as it indicates that there are ample earnings to keep paying a dividend, even if there are short-term financial strains that may temporarily depress a company’s earnings. Although dividends are paid from cash flow, looking at how well dividends are covered by earnings, rather than cash flow, creates a stricter criterion that helps to identify some of the safest and best covered dividends.
To help identify stocks that income investors might find interesting for both their dividend yield and their dividend coverage, we used Value Line’s online screening tool to find companies with payout ratios below 30% and dividend yields above 2.5%. One company (from the list of 40, see below) that stood out for its investment merit was glassmaker Corning, Inc. (GLW).
Corning produces specialty glasses, ceramics, and related materials. Its products are used for consumer electronics, mobile emission controls, telecommunications, and life sciences. The company has five operating segments: Display Technologies (40% of 2011 sales) makes glass substrates for liquid crystal displays (LCDs) used in notebook computers, desktop monitors, and LCD televisions; Telecommunications (25%) makes optical fiber and cable, as well as hardware and equipment; Environmental Technologies (13%); Specialty Materials (14%) includes Gorilla Glass a cover glass for portable electronic devices (including mobile phones, portable media players, laptop computer displays, and some television screens); and Life Sciences (8%). Research and development expenses totaled $562 million in 2011, or 8.7% of sales.
Shares of Corning have been on a wild ride since the company reported earnings on October 24, 2012. Many investors were concerned by developments revealed in the earnings release, causing the stock to drop 10% initially, and 20% in the three weeks following the news.
Although demand for its core products surpassed expectations in the quarter, management did express some concern over slowing global macroeconomic trends impacting demand for consumer electronics, as well as diesel engine filters in Europe, which may hurt the Environmental Technologies unit.
What appears to have driven the bulk of the decline, though, is the change in its pricing strategy for the LCD glass business. GLW boasts around 50% of this market, and its superior product quality has allowed it to charge a premium over competing vendors’ products. In the past, Corning would set a price and the competition would price lower to gain market share. Over time, especially when supply and demand dynamics were in flux, the premium would rise, leading to market share, volume, and price volatility. Although exact details of the new agreement have not been revealed for competitive reasons, basically, Corning can now better influence its market share and negotiate a fixed premium between its price and the market price determined by its competitors. In theory, this ought to increase visibility and volume stability, allowing Corning to better anticipate supply and demand dynamics, which, in turn, should allow it to allocate fabrication capacity to the most demanded product lines (i.e. less LCD display and more Gorilla Glass) and cut down on overall capital investment. Due to the lack of specifics, investors are not certain whether this will encourage more rational or aggressive pricing by competitors. The new structure should result in above-average price declines in the fourth quarter due to the premium that built up before the change, but deflation is expected to slow in the March interim. We view the operational effects positively, but acknowledge the potential for increased margin erosion.
Recently, the company made comments at an investor conference that have quelled some investors’ concerns and helped lift the share price. Reportedly, retail demand is staying on track and may surpass expectations. China TV unit volume was growing around 15% between August and October, thanks to stimulus measures and a better overall economy. The U.S. has been a bright spot as well, and GLW improved its outlook on current inventory levels. In response, Corning now expects glass volume to be up in the low single digits, versus prior expectations of down low-to mid single digits.
Outside of LCD glass, new products ought to support cash flow into the future, keeping the dividend yield and payout ratio above average. Gorilla Glass is the leader in the touchscreen market which we attribute to the product’s superior strength and thinness. The current quarter should prove successful due to a product refresh cycle leading up to the holiday selling season. Gorilla Glass revenues are expected to be up over 60% year over year in the interim and surpass $1 billion in sales in 2012. Looking long term, if hybrid PCs/Tablets that use touchscreens succeed, GLW would certainly benefit. Elsewhere, new and upcoming regulations in Europe and China for diesel engines should help the Environmental Technologies unit, and a fiber-to-the-home build out in Australia is a $1 billion deal for the telecom business over five years.
Corning’s current payout ratio is 23%, average for our list. It also pays a respectable dividend which was recently raised 20% and currently yields 3.24%. The company has expressed interest in continuing to reward shareholders with dividend hikes and share repurchases. Further, GLW expects to maintain R&D spending, which ought to ensure revenue growth continues for the foreseeable future. Conservative investors may wish to look elsewhere, though, due to this stock’s exposure to the uncertain consumer, telecom, and environmental markets.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.
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