Don’t Buy The Best Performing Asset of 2010

What is the best-performing asset of 2010? It isn't stocks: The S&P 500 is about where it was at the beginning of the year. It isn't gold, either, although this asset shares one characteristic with the yellow metal: You won't receive a cent of income on it while you own it. 

The answer is zero-coupon Treasury securities, which have returned as much as 21% year to date. That's an impressive number, but it doesn't justify piling into them now. After I explain why, I'll go on to suggest some stock market alternatives.

Stripping 101
Zero-coupon Treasurys (or STRIPs) are created by separating the interest and the principal payments on a regular Treasury bond. The result is a bunch of bonds with no periodic interest payments -- just a lump sum payment at maturity. Although this is mainly a market for institutional investors, individual investors can easily participate via PIMCO's Zero-Coupon 25+Year Index Fund ETF (NYSE: ZROZ  ) .

One of the reasons zero-coupon securities have performed so well is that they have higher sensitivity to interest rates than an ordinary Treasury bond. Thus, as interest rates have fallen, the value of the former has risen more quickly. However, buying either one looks like a losing proposition right now.

How do you win?
If you buy zero-coupon securities, two scenarios are possible (the same reasoning applies broadly to regular government bonds):

  • You don't expect to hold them to maturity. In this case, the greater sensitivity to interest rates will play against you if yields rise (yields are already at historically low levels). In the near term, it's certainly conceivable that yields might fall further, but the floor is surely in sight.
  • You expect to hold them to maturity, in which case you are locking in an annualized return somewhere near 4%, depending on the maturity. This amounts to a bet that inflation will be negative or near zero in the long term. Such a Japan-style "lost decade" scenario is possible but unlikely, in my opinion.

Five high-quality dividend stocks
There are better alternatives for your money at this time – and they provide an income return to boot. Some 15% of the stocks in the S&P 500 offer a dividend yield that exceeds the yield to maturity on the 10-year zero-coupon Treasury STRIP (3.37%). They include:

Company

Industry

Dividend Yield (Latest)

Plum Creek Timber (NYSE: PCL  )

Specialized REITs

4.54%

Philip Morris International (NYSE: PM  )

Tobacco

4.52%

Chevron (NYSE: CVX  )

Integrated Oil & Gas

3.82%

Johnson & Johnson (NYSE: JNJ  )

Pharmaceuticals

3.72%

Waste Management (NYSE: WM  )

Environmental & Facilities Services

3.69%

Source: Capital IQ, a division of Standard & Poor's.

Rising earnings and rising dividends
Furthermore, the dividends aren't static; investors can expect them to rise over time, protecting the purchasing power of the income they provide. That expectation isn't based on a hope and a prayer, either -- there are legitimate reasons to believe all of these businesses can continue to increase earnings over the coming years:

  • Plum Creek Timber is the first and largest publicly-traded timber REIT (Real Estate Investment Trust). In that capacity, it's also the largest private landowner in the United States. The story here is straightforward: Timber returns are largely based on biological tree growth, and I don't expect trees to stop growing anytime soon. Asset manager GMO forecasts that timber will return 6% annually above inflation over the next seven years.
  • Tobacco consumption is in long-term decline in advanced industrial nations, but that isn't the case in emerging markets. While Altria is entirely focused on the U.S., its international counterpart Philip Morris International generates nearly half its operating profits from Eastern Europe, the Middle East, Africa, and Asia. Analysts expect long-term earnings growth of just below 10% for the more cosmopolitan company.
  • Despite rising awareness of environmental issues, we are still producing huge amounts of garbage, and it will be tough to change that. In the highly concentrated waste disposal and treatment industry, size matters, and the big dog in this business is Waste Management.

Quality stocks are the better option
None of these companies are formal recommendations, but all of them look well positioned to continue increasing earnings and dividends in the foreseeable future. Assuming your investing horizon allows it, now looks like a good time to be buying high-quality dividend stock. Meanwhile, government securities (including zero-coupon STRIPS) may look appealing during periods of market volatility, but their expected returns currently look unattractive relative to other assets under all but the most bearish scenarios.

Not all dividend payers are created equal. Jordan DiPietro has identified the best dividend stock. Period.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Waste Management is a Motley Fool Inside Value pick. Philip Morris International is a Motley Fool Global Gains recommendation. Chevron, Johnson & Johnson, and Waste Management are Motley Fool Income Investor picks. The Fool has created a covered strangle position on Plum Creek Timber. Motley Fool Options has recommended buying calls on Johnson & Johnson. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (37)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 29, 2010, at 9:00 PM, ChuckWoolery wrote:

    What about McDonald's? They have steady stock prices and a good dividend to boot. Recession proof so far.

  • Report this Comment On July 29, 2010, at 9:01 PM, pinestholdings wrote:

    Wow. This is just, wow.

    "Timber returns are largely based on biological tree growth, and I don't expect trees to stop growing anytime soon."

    Are you kidding? This is analysis? As you can tell from my username, I am into the timber industry and most of my investing is there. I think I know it pretty well. This is the single silliest thing I have ever read on this site.

    Do you realize you are talking absolute gibberish? Why does the Motley Fool take people who know very little about an industry and put them on the main page talking about that industry.

    "I don't expect trees to stop growing anytime soon." - You want me to PAY for THIS analysis?

  • Report this Comment On July 29, 2010, at 9:05 PM, pinestholdings wrote:

    Oh, and by the way, Plumb Creek Timber doesn't pay a dividend. They distribute earnings to investors. Its taxed in a completely different way, as it is a "pass-through" entity rather than a corporation.

  • Report this Comment On July 29, 2010, at 11:06 PM, FleaBagger wrote:

    I think Waste Management changed their ticker to WM after Washington Mutual's demise left it available.

  • Report this Comment On July 30, 2010, at 12:06 PM, TMFAleph1 wrote:

    @pinetholdings,

    You DON'T pay for this analysis -- it's free.

    Alex D

  • Report this Comment On July 30, 2010, at 2:13 PM, pinestholdings wrote:

    Yeah, but if you are trying to entice people into paying, you should probably come with more than "trees are growing all the time... invest in timber!"; then get the wrong symbol for WM, then call Plum Creek a dividend when it isn't, etc... I like motley fool, but this article is utter gibberish.

  • Report this Comment On August 08, 2010, at 11:06 PM, philkek wrote:

    Thanks MF and fellow fools. You have given us some good stock symbols. I'll check out the fundamentals as part of my homework. I like dividend stocks and let the gains grow like MONEY TREES. Got a couple of laughs here, too ! haha Better Business Bureau warns us fools to investigate BEFORE we invest. Fool on for profits.

  • Report this Comment On December 12, 2010, at 9:02 PM, TMFAleph1 wrote:

    @pinestholdings,

    This is Robert Kleinschmidt's recent assessment of timberlands as an asset class:

    "Timberlands, particularly the more valuable timberlands, are highly related to the housing markets. But the underlying asset is—and has been historically—a terrific inflation hedge. AND ON TOP OF EVERYTHING ELSE, THE TREES GROW. So I want to own that asset if I can, and Weyerhaeuser represents one of the few publicly traded vehicles to play that theme." [Emphasis mine]

    Kleinschmidt is CEO and Chief Investment Officer of Tocqueville Asset Management. He has 35 years of experience in the investment management industry. Kleinschmidt has managed the Tocqueville Fund for nearly 20 years. With an 15-year annualized return of 8.15%, the Fund is ahead of roughly 90% of its peers, and ahead of the S&P 500 by over 1.5% on an annualized basis.

    It's nice to see an investor of Kleinschmidt's caliber echo what I said about timber nearly word for word.

    Alex Dumortier, CFA

    Source:

    The Call of the Contrarian,

    Barron's Interview: Robert Kleinschmidt

    Dec. 11, 2010

    http://online.barrons.com/article/SB500014240529702046502045...

  • Report this Comment On December 12, 2010, at 9:07 PM, portefeuille wrote:

    I like the comments made by pinestholdings.

Add your comment.

DocumentId: 1251219, ~/Articles/ArticleHandler.aspx, 4/24/2014 1:23:58 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement