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Ten-year U.S. Treasury notes hit record low yields last week and closed with a yield under 1.5%. The safety of an income stream -- even a tiny one -- and return of principal backed by the U.S. Treasury are attractive characteristics. However, with current puny yields and recent inflation reported at 2.3%, 10-year notes virtually guarantee a loss in purchasing power.
I've thought bonds have been overpriced for some time (and been wrong) and wanted to see how the prospects for 10-year Treasuries compare with some dividend-paying stocks. The stock team was chosen to get a good mix of strong businesses with established track records of annual raises, including through the rough markets a few years ago. I have CAPScalls on and own McCormick (NYSE: MKC ) , Southern (NYSE: SO ) , and RPM International (NYSE: RPM ) . I have an outperform call for Emerson (NYSE: EMR ) on my CAPS scorecard and it is on my watchlist. A friend asked me about Coca-Cola (NYSE: KO ) after a similar discounted cash flow match-up a few months ago.
Want market dominance? Quick, name the No. 2 company in spices. McCormick rules the space and has been spicing up its dividend for 26 straight years.
Like most utilities, Southern pays out a high current yield. Add in dividend raises for 11 years in a row, and it's easy to see how Southern earned its five-star (out of five) CAPS rating.
RPM may be a new name to many, but its paints, caulk, and sealants are commonly found in garages and workshops. The company paints a pretty dividend picture with 38 consecutive years of raises for shareholders.
Emerson sells automation, power, climate control, and other electrical equipment. It's also been amping up the dividend every year for 55 years. That's impressive for any company, but especially impressive for an industrial exposed to economic ups and down.
Dividends are nearly as reliable a product as soft drinks at Coca-Cola. This year the company announced its 50th consecutive annual dividend hike.
Recent Stock Price
5-Year Dividend CAGR
Source: Yahoo! Finance and author's calculations. CAGR = compound annual growth rate.
The Treasuries and company stocks were compared using the net present value of the investment, coupon, or dividend payments and value at the end of 10 years. Since my crystal ball is a bit cloudy, the following assumptions were used to estimate the unknowns.
- Treasury yield is rounded to 1.5%, and the notes return full face value at maturity.
- Stocks start with their current dividend rate and raise the payment each year in the same quarter as the past several years. To be conservative, dividend hikes are assumed to be only 75% of the past five years' compound annual growth rate.
- To be conservative, stock prices are assumed to be unchanged at the end of 10 years.
- Future values are discounted at the most recent consumer price index rate reported by the Bureau of Labor Statistics, 2.3%.
No surprise that Treasuries lose purchase power with the yield below inflation, but it may be surprising to some that all five stocks beat the notes under these assumptions.
Source: Author's calculations.
These aren't expected returns for the stocks; this scenario crimps dividend growth and stalls out the stock price. Even with the conservative assumptions, it isn't even close. In order for the worst stock return to be worse than Treasuries, McCormick's dividend growth rate would need to be less than a quarter of its recent track record, and the stock would need to fall by more than 10% over the next decade. Possible? Sure, but not likely.
I have no idea how stock prices or interest rates will move over the short term, but over a time horizon of many years, it's hard to see any scenario where long-term Treasuries at today's yields can outperform quality dividend-paying stocks.
Now it's your turn. Add a comment with your thoughts or a stock you'd like to see in a future match-up with Treasuries.