It’s becoming increasingly difficult to invest in the current environment.  Over the last few weeks some of the legends of the investment business have said this market is too difficult and have subsequently shut down their businesses.  It’s no wonder that we’ve seen an increasing demand for bonds and bond related instruments.  But that doesn’t mean equities are dead.  In fact, Morgan Stanley believes this is a perfect environment for high quality dividend paying stocks.  MS believes there is an opportunity here:

“Longer term we believe the rise in the spread between dividend yield and real bond yields may represent a statement about the market’s view on three things:

1) An outlook for weak long-term earnings growth that leaves a reduced possibility of P/E expansion, meaning that dividends
have to be a dominant part of total returns.  Historically a dividend yield of 2% would equate to a P/E multiple of nearly 17x (or alternatively a dividend yield near 3% supports the current market P/E of 14.5x). We do not think a 3% dividend yield is unrealistic. It would require the payout ratio to rise into the low 40% range – a move that would put it back close to the long-term average.

2) A higher risk premium (we estimate the implied ERP is now around 5.2%) that now needs to be compensated by a higher yield.

3) Investors doubt that companies can be trusted to reinvest earnings and create value. Companies are better off enhancing the payout ratio and returning money to investors, something we have yet to see in the current cycle.”

(Earnings and dividends are highly correlated)

MS created a high quality dividend screener to try to capitalize on this outlook.  The screen and results follow:

“We have run some screens to highlight stocks that look attractive on a yield basis. We apply some basic filters to raise conviction levels in the sustainability of current dividends.

1. We create a buffer by only considering stocks with yields more than 1% above the Treasury yield (a cutoff of around 3.7%).

2. We substantially lower earnings estimates for 2011, which have only just started to be downgraded. We cut consensus estimates by 20% for cyclical companies in Discretionary and Materials, 10% for Industrials, Energy and Technology, 20% for
Financials, 5% for non-cyclicals (Telecoms, Utilities, Healthcare, Staples). We then assess how many companies’ dividend payout ratios are still below 60%. Our top picks here are CVX, COP, PFE, ABT, MRK, CAG, JNJ, NEE, PEG and NU.

3. We try to eliminate the risk of future earnings and examine dividend sanctity by looking at how many times the 2011 dividend is covered by cash and marketable securities less short-term debt on the balance sheet. See Exhibit 9 for a list of these stocks. Our top picks here are LTD, LO, CVX, GPC, PFE, JNJ, MCHP, CAG, BMY and MRK. Besides the stocks mentioned above, we also have strong conviction in T, PNW, PM, ETR, CMS, KFT and HNZ on a yield basis.”

Source: Morgan Stanley


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

More Posts - Website

Follow Me:


  1. Thanks TPC. Part of accepting the fact that the Fed is pushing on a string and that we are in deflationary environment is figuring out what to do with cash that is earmarked for the market. A few more of these types of posts would be helpful.

  2. What is the description of the MS rating codes in the above table?
    Excellent article!

  3. Why cut off the yield at 3.7%? There are a mountain of preferreds, MLP’s, and more that pay a lot more than that and have the same level of safety (or better) than any of their listed stocks. Articles like that are weak and a bit misleading, IMO. They can do better.

  4. David Rosenberg has been advocating the SIRP (Safety and Income at a Reasonable Price) for months now. It is humorous watching many come around to the same view this late in the game.

  5. No surprise that there’s alot of healthcare stocks in that screen!

    These are the stocks that have had a material impact on cheapening the stock market recently on a div yield or earnings yield basis.
    People go on about dividend/earnings yields versus treasurys etc, but the very stocks that provide a decent yield and trade on a very low p/e are the very stocks the same people refuse to touch because of the healthcare reform headwinds out there etc. They shun AT&T for similar reasoning…structural changes ahead in the business model
    A p/e of 7 on a stock like Pfizer is saying that the dividend and eps stream is very vulnerable.

    I am not saying any of the above stocks dont have value. In fact I think the market has over-egged the downside on stocks with structural headwinds; Healthcare, AT&T, Microsoft (Cloud computing, Open Office, Linux etc etc) and that there is some real value there relative to treasury yields even adjusting for the potential changes ahead

    I guess my point is that the mainstream press complains alot about the growing divergence between Stock Mkt yeilds and Treasury Yields. yet thse same people wouldnt touch a Microsoft, Pfizer or AT&T with a bargepole. They cant have it both ways, because after you strip out these “structural headwind” stocks, the remaining market aint that cheap!!

  6. Roll into the equation the relatively low debt/equity-capital/equity ratios in combination with healthy ROE(over 15% based on both GAAP and CF/Sh) of certain large, resourceful companies (including those with yields in the 2% to MS’ 3.7% range), and you will find an interesting group of companies with PEs at or below 14 … some under 10.

    There’s long term value out there, folks, in wisely selected dividend stocks, most of which can be expected to survive this crappy multi-year economic environment in good shape.