The 5% Solution?

A few years ago I wrote an article for theStreet.com where I tried to construct a diversified portfolio that yielded 4%. While the overall yield came in just below 4% it covered a lot of bases toward being diversified. The objective was not that anyone should have bought that portfolio but I wanted to try to illustrate my point from the other day (I have been making this point for years) about managing the yield of the overall portfolio, at least that was the intention.

The other day I also mentioned that there are now a lot more stocks that yield 3% than there was four years ago, at least this appears to be the case. With yields generally higher I thought it would be interesting to update the 4% portfolio from a few years ago in search of 5%. The names are stocks that I generally keep tabs on (a couple of exceptions) but don't own which should tell you something.

Financials-

Westpack Bank (WBK) 7.8% yield; This is one of the big four Aussie banks. If I am wrong about the risks in the housing market then this would be a good hold. The big difference between WBK and ANZ (ANZBY) that I sold in May is that ANZ has a lot more business throughout Asia than WBK.

Annaly Capital Mortgage (NLY) 14.2% yield; I am quite certain I am never going to own a mortgage REIT but the name has been a good hold more often than not and many people do recommend the name. I could easily be wrong but whatever happens it will happen without me. The thing with mortgage REITs is that they chug along just fine and then something catastrophic happens. My introduction to this came with Northstar Financial which had symbol NFI before it blew up, fortunately I never owned that one. NLY has cut in half twice in the last ten years. Anyone who thinks they can be out in front of the next time that happens might be willing to take the risk in exchange for the yield.

Energy-

Enterprise Products Partners (EPD) 5.2% yield; EPD is one of the big gorillas in the MLP space it is relatively low in volatility. There are plenty of MLPs with much higher yields, generically speaking going in higher in yield should mean taking on more volatility. This would not be my first choice but I don't believe there is any realistic threat of the name hurting anyone in some unique fashion (if all MLPs cut in half for some unforeseen reason EPD would not be immune).

Total (TOT) 6.32% yield; Total is big French oil. I am not a fan of Europe from the top down but it held up much better than iShares France (EWQ). TOT was down 4% in 2011 versus a 19% drop for EWQ. If I am wrong about Europe or if Europe goes up a lot in the face of a lousy fundamental backdrop then TOT should participate. TOT is also cheap, Google Finance has it at 7.4 times earnings.

Healthcare-

AstraZeneca (AZN) 5.8% yield; AZN has a PE of 6.3. Like all of the big drug companies it has a bunch of products that you have heard of and has a few interesting things in the pipeline. There are always patent issues with these companies and to the extent the company is pretty generic, its five year chart looks a lot like many of the other large drug companies although most of these stocks lag the broad ETFs like Healthcare SPDR (XLV).

Sanofi (SNY) 4.8% yield; Pretty much everything about AZN applies to SFY but SFY's PE is 15.9.

Technology-

Taiwan Semiconductor (TSM) 4% yield; within semiconductors there are many 3% yielders to be found. TSM has always had a high yield. The stock has done relatively well over the years compared to the iShares Taiwan ETF (EWT). There are a couple of other easily accessible Taiwanese semiconductor names but TSM appears to be on the surest footing.

DDi Corp (DDIC) 5.1% yield; This name got mentioned once in passing on CNBC, it makes printed circuit boards which can be thought of as a commodity which embeds some risk into the name and this is reflected in the price over the last few years but for a microcap it did not go down as much as you might think in 2008. Also the PE is just below 10 and it has very little debt (far more cash than debt). Obviously this would a pretty aggressive hold but the stock has been around for a while and after blowing up in 2004 seems to have matured.

Industrials-

Douglas Dynamics (PLOW) 5.6% yield; PLOW makes equipment and material for snow removal. Similar to DDIC this is a very small company but has a much shorter track record than DDIC. It has done very well since coming out a year and half ago, outperforming iShares Russell 2000 (IWM) by about 25%. Its end market appears to be small business owners that are contracted by municipalities, HOAs and the like. In Yavapai county (where I live) the country owns the vehicles which would seem to be more prevalent. Given the state of the states perhaps there will be more outsourcing of the work and the repair headaches which might be a slow moving catalyst for PLOW?

Lockheed Martin (LMT) 4.9% yield; From the top down LMT is not much different than the other large cap defense contractors but LMT has the highest yield. I prefer Northrup (NOC) and know that name much better but these stocks, add General Dynamics (GD) to the list, seem to take turns being the best performer from year to year. While I continue to prefer NOC long term LMT should hold its own without hurting anyone.

Staples-

Reynolds American (RAI) 5.4% yield; Obviously Altria (MO) and Philip Morris (PM) are the big names in this space. I prefer PM, we own it for clients, because there are less obstacles to smoking in other countries than in the US but RAI has held its own price wise. In addition to tobacco stocks offering high yield in this space there are plenty of booze stocks with high yields also.

Discretionary-

Leggett & Platt (LEG) 4.8% yield; It is difficult to find yield in this sector. LEG makes a lot of stuff, components for products such that it is unlikely you would see their name on anything, at least I cannot recall seeing the name on anything. This sort of company reminds be of a company from a long time ago called Applied Magnetics which made the arm that went on disk drives back then but with LEG the products are much simpler. The stock is a small cap, went down every bit with the market during the crisis but has come back a little faster. The stock is not cheap but the dividend is well covered and earnings are forecast to grow meaningfully in 2012 setting the stage for an increase in the dividend.

Telecom-

Telstra (TLSYY) 8.1% yield; This is the Ma Bell of Australia. It is not riskless. There have been issues with the future of broadband not going favorably for the company. It went down much less than the ASX 200 during the worst of the crisis, then lagged the index in 2010 but lately has outperformed. I would also note that its chart has never looked much like the US telecom sector as measured by Vanguard Telecom ETF (VOX) which we own for clients.

Utilities-

National Grid (NGG) 6.1% yield; NGG is a UK utility but has a presence in the northeast US as well. For a utility it went down a lot in 2008, almost as much as the iShares UK (EWU). It then hugged the index for a while but in mid 2011 when EWU turned lower NGG actually drifted higher and had a much better 2011. The dividend is easily covered by earnings, the current PE is 10 but not surprisingly it has a lot of debt. This is not riskless but as with many of the others, unlikely to turn out to be a house of cards.

Materials-

Terra Nitrogen (TNH) 8.2% yield; This is probably a common name but I don't know if people realize that it is a partnership. It has no debt, pays out almost all of its earnings (by definition) and is a volatile stock. Southern Copper (SCCO) is also a high yielder for anyone not wanting too much exposure to partnership stocks. To be clear, one is not a substitute for the others, the two charts look to be almost negatively correlated but SCCO also yields about 8%.

Again, we don't own these stocks for clients. If a portfolio is built with nothing but these types of stocks then the risk becomes finding out they are leveraged to the same types of unpredictable risk after they have all gone down a lot. I generally would be more concerned about risks I can't see coming. This type of threat is reduced when you make sure you take in holdings with all typed of attributes. With NLY, again a name I can't imagine using, I could be overly concerned versus the reality which is fine but complex dealings in mortgages is not an area I want to own.

A practical application could be summarized in the following example. It would be reasonable for someone to own Fedex as a proxy for industrials. In 2009 it trounced the Industrial SPDR (XLI) and has since tapered off versus XLI. Fedex only yields 0.6%. After a great 2009 for the SPX it made sense to think that the market would not do as well in 2010 making yield more important. A swap from something like Fedex to something like LMT obviously increases the yield of the portfolio. A few trades like this would be enough to meaningfully increase the yield of the entire portfolio. The difference between a 2% yield and a 3.5% yield won't mean much in a year like 2009 but did mean a lot in years like 2010 and 2011 and I think will mean a lot in 2012.

As a bit of a disclaimer on the stocks mentioned, I keep tabs on these stocks I do not know them cold and don't own them. My opinion is that none of them will prove out as frauds or truly hurt anyone relative to other stocks in their respective groups (if all mortgage REITs go down by 75% NLY will too but it don't think it would go down 75% if the group goes up by 5%).

One more point is that generically speaking there comes a point higher yields lead to more risk. A 5% yield is pretty modest these days for an MLP but there are plenty that yield 9%. Not that you shouldn't own a 9% yielder but a portfolio full of them has a high likelihood of ending in tears.