Ten-year U.S. Treasury notes were one of the best performers of 2011, returning more than 16%. The safety of an income stream and return of principal backed by the U.S. Treasury are attractive characteristics. However, with current coupon rates under 2% and recent inflation reported at over 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. Since perceived safety is a key point for the government paper, the debt's competition will be the only four U.S. companies with something Treasuries lost last year -- a AAA rating from Standard & Poor's. The four contenders are listed below, along with some key information.
|
Company |
Recent Stock Price |
Dividend Yield |
5-Year Dividend CAGR |
|---|---|---|---|
| Automatic Data Processing (Nasdaq: ADP) | $54.40 | 2.9% | 11.42% |
| ExxonMobil (NYSE: XOM) | $86.02 | 3.5% | 7.99% |
| Johnson & Johnson (NYSE: JNJ) | $65.48 | 2.2% | 8.73% |
| Microsoft (Nasdaq: MSFT) | $27.40 | 3.1% | 14.87% |
Source: Yahoo! Finance and author's calculation. CAGR = compound annual growth rate.
The match-up
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.
- Treasuries pay 2% and return full face value at maturity.
- Stocks pay 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, 3.4%.
Results
No surprise that that Treasuries lose purchase power with the yield below inflation, but it may be surprising to some that all four stocks beat the notes under these assumptions.
| Investment | Change in Purchasing Power |
|---|---|
| 10-year Treasury | (11.3%) |
| ADP | 7.4%% |
| ExxonMobil | (3.5%) |
| Johnson & Johnson | 11.8% |
| Microsoft | 12.2% |
Source: Author's calculation.
These aren't expected returns for the stocks, this scenario puts the brakes on dividend growth and stalls out the stock price. It's hard to imagine a scenario where these four stocks don't have some gain in share price over the next decade.
Even with the conservative assumptions, it isn't even close. In order for the worst stock return to be worse than Treasuries, Exxon's dividend growth rate would need to be half its recent track record, and the stock would need to fall by nearly 10% over the next decade. Possible? Sure, but not likely.
- Add ExxonMobil to My Watchlist.
- Add Microsoft to My Watchlist.
- Add Johnson & Johnson to My Watchlist.
- Add Automatic Data Processing to My Watchlist.
