Over the past two years, I bought more shares of higher-yielding dividend stocks for two reasons. First, interest rates seemed likely to stay low for the foreseeable future, keeping dividend stocks more attractive than bonds. Second, I believed that as the market hit record highs, investors would pivot away from riskier growth stocks toward conservative income plays to lock in their gains.
I bought my top three holdings as of this writing -- AT&T (T 2.31%), GlaxoSmithKline (GSK 0.38%), and Bank of America's Series D Preferred Stock (NYSE: BAC-D) -- with those strategies in mind.
Back when I bought AT&T in the low $30s, I expected the stock to rally only moderately as investors fled to more conservative dividend plays. Yet the stock rallied 26% over the past 12 months, easily outperforming the S&P 500's 14% gain during the same period. That's because telco stocks rallied alongside utility stocks as "safe" plays for a frothy market trading at 25 times earnings.
That rally reduced AT&T's dividend yield to 4.6% -- which is near a multiyear low for the Dividend Aristocrat. However, AT&T's current P/E of 18 remains low compared to the market and the industry average of 25 for domestic telecom companies. Nonetheless, the threat of rising interest rates will likely limit AT&T's upside potential over the next few quarters.
AT&T's free cash flow got a tremendous boost from its acquisition of DirecTV, and the bundling of DirecTV plans with unlimited wireless data could drive growth at both businesses. Analysts expect AT&T's revenues to rise 13% this year (due to the DirecTV acquisition) and another 2% next year. Earnings are expected to rise about 6% this year as well as next year -- indicating that it should keep posting slow and steady growth.
Unlike AT&T, GlaxoSmithKline stock performed exactly as I thought it would. It went nowhere, and still hovers near my average purchase price of $43.94. However, that still makes it a stable and cheap income play with a forward P/E of 16 and a forward dividend yield of 5%.
Many investors have avoided GlaxoSmithKline over the past year due to the threat of generic competition against Advair, its flagship COPD (chronic obstructive pulmonary disease) drug, which lost patent protection in the U.S. back in 2010. A generic version of Advair hasn't been introduced yet, since GSK still holds the patent on the drug's Diskus inhaler until next year. But once that patent runs out, generic rivals like Mylan (NASDAQ: MYL) are expected to quickly enter the market.
However, GSK has already prepared for that competition by lowering the prices on Advair to near-generic levels. Sales of Advair's COPD successor, Breo Ellipta, have also been improving over the past few quarters, thanks to a label expansion for adult asthma patients.
GSK also swapped its higher-growth, higher-risk oncology portfolio for Novartis' (NYSE: NVS) lower-growth, lower-risk vaccine portfolio last year. That move also established a joint venture in OTC and consumer products between the two companies. These moves have stabilized GSK's growth over the past few quarters, and analysts expect its revenue to fall 2% this year but rise 6% next year. Earnings are expected to rise 12% this year and 7% next year, while a weaker post-Brexit pound is expected to boost GSK's overseas profits.
Bank of America Preferred Stock
Bank of America offers many classes of preferred stock, which function very differently from its common shares. If Bank of America went bankrupt, the common shares would likely go to zero while the preferred shares would be liquidated at a "par value" like a bond. If the stock is "callable," it means that Bank of America can also buy back the stock at its par value after the "call date" passes.
For example, the Bank of America Series D shares I'm holding have a par value of $25, but currently trade at $25.78 as of this writing. If Bank of America becomes insolvent, the shares would be redeemed for $25 per share. Since the shares also became "callable" after Sept. 14, 2011, Bank of America can also call back the stock at anytime for $25 per share. But until that happens, the stock will pay a 6% quarterly dividend.
Since a preferred stock is more like a bond than a common stock, it's much less volatile than Bank of America's common shares. My D shares have stayed flat since the beginning of the year, but Bank of America's common shares have declined more than 7% while paying a much lower dividend.
Are these stocks right for you?
I'll likely reduce my exposure to these high-yielding dividend stocks as interest rates rise, but AT&T, GSK, and Bank of America's Series D are all fairly reliable income generators for now. Investors looking for some decent dividend plays should take a closer look at these three stocks.