Stocks With Safety Nets

Looking at the stock market these days, I'm reminded of the Simon and Garfunkel hit "Bridge Over Troubled Water." It's hard to see an end to the wall of worry investors face these days. When a premier investment bank like Bear Stearns (NYSE: BSC  ) can lose 90% of its value in less than a month, we are swimming in troubled waters indeed. "Shark-infested" might be a more apt description.

Making it through the next six months with your portfolio intact will likely be a challenge. There's no shortage of strategies out there to minimize risk while generating a decent return -- from holding stocks that prospered during the last recession to keeping your powder dry by upping your mix of cash.

A safe play in cash
From a safety perspective, it's hard to argue with the cash approach. According to Bankrate.com (Nasdaq: RATE  ) , you could plunk down $10,000 in a money market fund that yields an APY as high as 4.05%. (My anxiety level jumped a notch when I noticed that Countrywide (NYSE: CFC  ) was offering one of the highest money market yields available.) In today's environment, it's not altogether clear whether these funds are as safe as they used to be. In contrast, Certificates of Deposit at your local bank are FDIC-insured up to $100,000, but you'll sacrifice some yield for that protection. CDs have recently averaged roughly 3%.

Stocks have safety nets, too
But you don't have to turn to cash to feel safe from the commotion rumbling our markets. While they're obviously not as safe as cash, some stocks have safety nets, too. They're called "dividends."

Companies paying high dividend yields effectively put a floor on their stock prices, even when those prices head south. It's not an absolute floor, nor as ironclad as FDIC insurance, but it's highly relevant for cautious investors.

As long as the company can continue paying its dividend, investors will eventually start buying the stock simply to capture a superior yield. The lower the stock goes, the higher the yield becomes, thus creating a floor for the share price.

Cash flow is critical
There's an important caveat in that sentence: as long as the company can continue to pay the dividend. Any stock-screening tool will quickly give you a list of the highest-yielding stocks, but you can't simply stop there. Four of the five highest-yielding stocks in the S&P 500 today are financial institutions, with Bear Stearns near the top of the list. But in today's environment, some of these companies may not be around for long.

Screening for likely candidates
A hearty dividend yield is a great starting place, but these stocks also need to generate robust cash flow to pay that dividend, even in tough times. They need to be leaders in industries that aren't likely to collapse, and they need to have a manageable amount of leverage. Stocks that might fit this description include:

Company

Yield

Dividend/share

CFO/share

CAPS  Rating

Waste Management (NYSE:WMI)

3.2%

$1.08

$4.89

*****

SYSCO (NYSE:SYY)

3%

$0.88

$2.09

****

General Electric (NYSE:GE)

3.4%

$1.24

$4.61

****

DuPont (NYSE:DD)

3.5%

$1.64

$4.78

****

Data for most recent fiscal year, from Capital IQ and Motley Fool CAPS.

These are not necessarily stocks you should buy today; they're simply the results of a screen that suggests they possess the financial characteristics of safety-net stocks:

  • Each of these companies is a mammoth businesses in fields that aren't likely to collapse. For example, I can't imagine that the demand for waste management will hit a downdraft this year, even if consumers spend less.
  • They all generate cash flow from operations that more than doubles their dividend, making it unlikely that their dividend payouts are in any kind of near-term jeopardy.

The world isn't perfect
All of these companies face at least a few challenges these days. SYSCO is the largest distributor of food products to the restaurant business, where a lot of companies are struggling. DuPont has seen its growth rate slow in recent years, although emerging markets have recently provided a boost. High oil prices have recently seen Waste Management's profits trimmed.

But who isn't finding it a little harder to make a buck in this environment? You're not looking for the next 10-bagger here. Sure, I love growth stocks as much as the next person. But you must ask yourself whether this is the right environment for that stock-picking strategy. If you're looking for a safety net to carry you through these troubled waters, owning superior companies that pay high dividends may offer you the smoothest sailing.

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