Look Abroad to Protect from Inflation - Analyst Blog

Income is hard to come by these days, with interest rates at rock-bottom levels. The 10-year T-note still yields under 3.5%, far below its long-term average. Meanwhile, fears of inflation are starting to escalate. While I think that those fears are unfounded here, at least for core prices, it is true that inflation has become a much larger problem around the world, and it is possible that it could spread here.

Headline inflation is picking up as the price of gasoline and food commodities, are rising fast. Core inflation is the key for setting monetary policy, but investors have to be concerned with headline inflation.

The basic idea of investing is that you consume less today so that you can consume more tomorrow. You want to be able to consume more (or better) stuff in the future, not just pay more for the same amount of stuff. The stuff that you will consume tomorrow presumably includes food and energy. It would not take a huge increase in inflation to rapidly eat up the real return from buying a 10-year T-note. Even if you do not plan to hold it for the full ten years, rising inflation will cause bond yields to rise, and bond prices to fall, so you will take a capital loss.

While there is always uncertainty in investing, the one thing you can know for sure is that the coupon on the 10-year T-note you buy today is not going to go up. That is why they call it fixed income.

Consider Dividend Yields

Question: How can you get both income now, and some protection against future inflation? Answer: Dividend-paying stocks. In general, firms with a history of raising their dividends are more likely to continue raising their dividends than non-dividend paying stocks are likely to start them, or that a company that has held its dividend steady for the last five years will all of a sudden decide to become more generous with its shareholders.

Of course, past performance is no guarantee of future results. Then again, there is no guarantee that Ichiro will get a hit when he comes up to bat in the bottom of the 9th, but you would rather have him at the plate than a .175 hitter.

The last thing you want when buying a dividend stock is for that company to suddenly cut or eliminate its dividend. Not only would you not get that income you were counting on, but the price of the stock would probably fall sharply. The best protection against this is a low payout ratio. If a company cannot consistently earn more than it pays in dividends, eventually that dividend will have to be cut. Also, if the company is not retaining much of what it earns, it is very hard to grow earnings in the future, and thus raise dividends.

Solid Companies Yielding More Than the 10-Year

The screen below shows all the stocks that yield over 3.5% (i.e. more than you can get today on a 10-year note) that have grown that dividend at more than 10% per year over the last five years. I also included the requirement that the stocks have a payout ratio of less than 70%. Even though dividend investing is a long-term investment strategy, you don’t want to buy a stock because it has a yield of 5% and then see it almost immediately fall by 10%.

To help guard against that, I also eliminated all firms with Zacks #4 Ranks (Sell) or Zacks #5 Ranks (Strong Sell). If you are only looking for one or two names to add to a portfolio, rather than create a whole diversified portfolio of income names, the first ones you should look at are the ones that are Zacks #1 Ranks (Strong Buy) or Zacks #2 Ranks (Buy). Since dividend yields do tend to be somewhat mean-reverting over time, I would also tend to be more interested in the firms where the current dividend yield is more than the five-year average dividend yield.

What the screen reveals is that is it possible to have a well-diversified portfolio of firms with high and rising dividends, but that you might have to look abroad to find some of your firms. I happen to be bearish on the dollar (bullish on most other currencies), so the fact that a company is based abroad and thus probably makes most of its money overseas is a feature, not a bug. If the Dollar weakens, then those Euros or Yen they are earning will be worth more dollars.

A Closer Look at Screening Results

Let’s take a little bit of a closer look at the number #1 and #2-ranked firms on the list. It just so happens that three of the four are in the same industry, so you will not get a diversified portfolio by buying all of them — at least not diversified by industry — but very well diversified geographically.

BBVA Banco Frances (BFR) is one of the largest banks in Argentina, with 271 branch offices and $6.9 billion in assets. It is highly profitable, sporting a trailing return on assets of 4.17% and a trailing return on equity of 34.8%. It is also very modestly valued with a P/E based on expected 2012 earnings of under 8x.

The current dividend yield is more than twice its five-year average yield. It holds the coveted Zacks #1 Rank, which means it is a good bet for a short-term pop in addition to the long-term income and income growth story. The downside is that it is based in Argentina, which does not exactly have the best history of economic or political stability over the last century or so.

Telefonica (TEF) is based in Spain, but is a major telecommunications provider throughout Europe and Latin America. That includes Internet access and wireless as well as land-line services. Telecommunications are often a good way to play emerging markets, and the Latin American portfolio gives you a lot of that, along with the relative stability of Europe. Investors are probably somewhat spooked by its connection to Spain, which is of course the S in PIIGS.

The dividend is well above its five-year average, and with a payout ratio of just 38% there is plenty of room for it to continue raising its payout. TEF also holds the coveted Zacks #1 Rank. Valuation is more than reasonable, trading at 9.4x 2012 earnings expectations.

Royal KPN (KKPNY) — if investing in Argentine Banks or Latin American telecoms are too dicey for you, how about a telecom company that serves Holland, Belgium and Germany? Royal KPN provides wireless services to 33.4 million customers, wireline voice services to 4.7 million customers, broadband Internet services to 2.5 million customers, and TV services to 1 million customers. It does not have quite the growth potential of Latin America, but Holland and Germany are pretty stable places.

As with the others, the current yield is higher than the five-year average, but not as dramatically so. Valuation is very reasonable at under 9x next years earnings. With a Zacks #2 Rank, you might get a nice short-term pop in addition to a steady and growing flow of dividends.

Telus (TU) is sort of a similar story to Royal KPN, only based in Western Canada, not Western Europe. It serves about 7 million subscribers with wireless and land-line service, including 3G and 4G wireless services.

Its current yield is also above the long-term average, and the P/E is very reasonable at 11.6x next year’s earnings. Canada, particularly Western Canada with its natural resource-based economy is growing nicely, and I like the prospects for the Canadian Dollar (Loonie) even more than I like the prospects for the Euro over the intermediate term. Its payout ratio is a bit higher than the others at 63%, but is still well within the safe dividend zone.

As always, remember that a screen should be the starting point for your investing investigation, not the end point. However, if you want both current income and some protection against potential inflation, the list below is as good a place as any to start looking, and don’t forget to look abroad as well as at home.

Company	Ticker	Div Yield	Div Yield 5 Yr Avg	Payout Ratio	Div 5-Yr Growth	P/E Using Next FY Est	Zacks Rank	Mkt Cap ($ mill)
Hudson City Bcp	HCBK	6.08%	3.30%	0.55	21.44%	11.35	3	$5,198
Banco Franc-Adr	BFR	6.01%	2.76%	0.15	75.05%	7.97	1	$1,967
Telefonica S.A.	TEF	5.55%	3.48%	0.38	38.41%	9.37	1	$114,556
Brookfield Infr	BIP	5.52%	6.29%	0.35	20.42%	9.03	3	$1,418
Lorillard Co	LO	5.49%	4.12%	0.66	27.83%	11.53	3	$13,790
Banco Santan Sa	STD	5.29%	4.98%	0.51	15.03%	N/A	3	$99,450
Entergy Corp	ETR	4.98%	3.28%	0.47	10.35%	10.81	3	$11,926
Royal Ptt-Adr	KKPNY	4.94%	4.32%	0.54	13.94%	8.96	2	$26,200
Digital Rlty Tr	DLR	4.85%	3.42%	0.63	15.92%	12.89	3	$5,127
Shaw Comms-Cl B	SJR	4.48%	3.33%	0.67	32.61%	12.77	3	$8,453
Telus Corp	TU	4.48%	4.14%	0.63	14.86%	11.59	2	$6,984
Cms Energy	CMS	4.39%	2.29%	0.62	44.89%	12.37	3	$4,823
Alliance Res	ARLP	4.19%	6.57%	0.5	14.07%	10.25	3	$3,019
Total Fina Sa	TOT	4.14%	4.25%	0.41	23.92%	8.06	3	$133,925
Intersil Corp	ISIL	3.98%	2.48%	0.52	19.59%	13.08	3	$1,506
Rogers Comm Clb	RCI	3.95%	2.15%	0.44	91.54%	10.84	3	$15,946
Philip Morris	PM	3.93%	4.40%	0.66	10.56%	13.32	3	$117,029
Turkcell Il-Adr	TKC	3.85%	3.45%	0.45	21.43%	10.19	3	$13,508
Unilever Plc	UL	3.74%	3.36%	0.54	12.35%	12.07	3	$86,030
Lockheed Martin	LMT	3.73%	2.28%	0.41	21.77%	9.31	3	$28,091
Alliance Hldgs	AHGP	3.71%	5.45%	0.68	23.90%	15.35	3	$3,400
Abbott Labs	ABT	3.66%	2.82%	0.42	10.49%	9.72	3	$74,330
Microchip Tech	MCHP	3.66%	4.18%	0.7	11.11%	16.31	3	$7,107
Novartis Ag-Adr	NVS	3.60%	2.36%	0.32	21.57%	9.72	3	$126,904
Intel Corp	INTC	3.56%	2.62%	0.31	11.55%	9.18	3	$111,791