Notice: Are you looking for extra income? These blue chip stocks can crush bonds with a 5% payout

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If you’re a widow, orphan, or other cautious investor, consider adding stocks in utilities, telecommunications, and other consumer goods to your portfolio this quarter.

You should seek the best low-risk payments overseas, including European, Japanese, and other foreign stocks, while significantly reducing your exposure to the United States.

And you should be thinking about defense, because many stocks that look like they have to pay a big dividend will instead give investors a big slap in the face, cutting their payouts or canceling them altogether.

This is what the “quality income” strategists of the investment bank SG Securities say in their latest report.

Dividend forecasts around the world were cut by 13% in the last quarter, they write. But the cuts to stocks in their quality income base have been cut by just a third of that.

Income invested in stocks is becoming increasingly important, thanks to the collapse of interest rates. Once upon a time a grandmother could put her money in investment grade certificates of deposit, treasury bills, municipal bonds, and corporate bonds, and earn a good 6-7% a year.

No risk. No volatility. No problem.

No more.

Today, 10-year Treasuries have the lowest interest rates in history at just 0.6%. A one-year CD pays just over 1%, if you’re lucky. So-called “inflation-protected securities,” special bonds issued by the federal government, now promise to earn you less than inflation for the next 30 years.

So it makes sense for income investors to look to stocks.

But investing in income is a dangerous game because stocks are very different from bonds. Prices are volatile and payouts can be reduced or increased. If a company enters Chapter 11, bondholders usually get at least something back because they have the first right to the assets. Shareholders rarely get a bean.

Investing in stocks with the highest dividend yields, for example, is generally a bad idea. Firms with the highest apparent returns tend to be struggling. Either they pay the dividends by borrowing money, a game of chance that rarely ends well, or they are on the verge of cutting the dividends.

This is the case right now with a lot of stocks of oil and commodities, for example, and a ton of European banks. Fund manager Mark Urquhart at Baillie Gifford, based in Edinburgh reports that, according to some estimates, global dividends from equities could be reduced this year by 25 to 40%.

Data compiled By Ken French, the legendary professor of finance at Dartmouth College, finds that the best long-term returns have come a long way from stocks in the second or third quintile versus the highest returns. In other words, those whose dividend yield is well above average, but not at the top. Historically, the gaps have also been huge. Since the 1920s, stocks in the second quintile – the bottom second out of five – in terms of dividend yields have beaten the top quintile by more than a percentage point per year on average, and stocks in the middle of the pack by almost two solid points. (Of course, as recently stated, the past is a very imperfect guide to the future.)

Andrew Lapthorne and George Oikonomu, SG’s top numbers, say an even smarter strategy has been to analyze corporate earnings and balance sheet risks as well, to make sure you’re buying the best dividend-paying stocks. best suited to cope with turbulence.

It might not have seemed so important a few years ago. But, oh boy, does that seem important now.

So where are you looking? Their last “quality income” basket is heavily invested in telecom stocks (21% of the portfolio), consumer goods (also 21%), public services (19%) and health 11%). Inventories of “consumer goods” also include Big Tobacco and some stocks such as Unilever.

Investments in financial securities: Zero.

Oil and Gas Holdings: Almost zero.

And it’s very international. They are only 13% invested in US stocks, against around 45% in Asia and Australasia, and 40% in Europe. Japan, at 19%, has the largest weighting by country.

It may not be a surprise. Many Japanese stocks have balance sheets so strong they have net cash, not net debt, and many have finally increased their stingy dividends. (Your correspondent has part of his retirement portfolio in the iShares Japanese Value ETF EWJV,
-0.31%
precisely for this reason.)

Big American names on the SG list include Coca-Cola KO,
+1.05%,
Kellogg K,
-0.08%,
Pfizer PFE,
-0.19%,
Verizon VZ,
+ 0.54%,
Philip Morris International PM,
+1.36%,
Altria MO,
+ 0.75%,
and Gilead Sciences GILD,
-1.85%.

Predict dividend yield this year for that basket of seven stocks: a hefty 5.1%, according to FactSet.

It is difficult for fund investors to access this stuff just through mutual funds or exchange traded funds. For a variety of reasons, including compliance and marketing, your general “income” or “value” fund will not take big bets on individual companies or sectors like this.

Bottom line: If you are looking for income, it is far from crazy to look to stocks. But be careful what you buy. You need to look beyond the dividend yield and understand the business. Otherwise, you risk having unpleasant surprises.

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