How to Get a 10 Percent Dividend Yield Before Everyone Else

David Sterman
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Posted: Dec 25, 2011 12:01 AM

Looking at the current state of the economy, it looks like we're heading into another year of very low interest rates and insultingly low yields for most bonds and certificates of deposit (CDs). These days, a stock with a dividend yield as low as 2% is enough to get many investors' attention. But that's not good enough for me. Many of these dividend-paying firms can do a lot better. They are retaining almost all of their earnings while still earmarking relatively small amounts for a dividend.

To see how often this happens, I scanned all of the companies in the S&P 600, focusing on stocks that paid 25% or less of their profits as a dividend. These companies could easily manage to boost that payout ratio up to 50% without jeopardizing their financial health. By doing so, small yields might suddenly become large yields, giving investors a reason to own these names ahead of time.

Take aeronautics firm AAR Corp. (NYSE: AIR) as an example. The company has earned at least $1.21 a share in each of the past five years and is only now beginning to pay dividends again after having suspended it in fiscal (May) 2003. In the most recent quarter, AAR earned $0.41 a share and issued a $0.075 quarterly dividend. That works out to be $0.30 a share in dividends on annualized basis, good for a 1.6% yield. But suppose management hiked the dividend so it equated to half of net income. With a forecast of $2 in earnings per share (EPS) in the current fiscal year, that dividend payout could be hiked to $1, equating to a more robust 5.3% yield.

In the table below, you'll note a group of fairly low-yielding stocks. But if all of them took their payout ratio up to 50%, then you'd be looking at much more impressive dividend yields.


 
Of course, some companies are loathe to pay out a lot of capital in dividends for fear that business will turn south and cash will become scarce. Chicago-based Littlefuse (Nasdaq: LFUS), which makes circuit-protection devices, posted erratic annual results throughout much of the past decade. For example, EPS plunged from $1.64 in 2007 to just $0.37 in 2008 as the economy slowed. Yet a steady expansion has put the company on much surer footing lately. In the last quarter of 2009, net income finally moved back up above $10 million for the first time in more than two years, and it hit $25 million by the third quarter of 2010, staying robust ever since.

Littlefuse's quarterly net income is likely to top $90 million this year, yet the company has paid out just $10 million in dividends this year and accounting for an upcoming fourth-quarter divided, we're still only talking about $15 million. Let's suppose management grew confident that business won't sharply slump in 2012 and decided to boost the dividend payments to $45 million (for a 50% payout ratio). What is now a 1.5% dividend yield would quickly become a 4.5% dividend yield.

Cascade Corp. (Nasdaq: CASC)
This Oregon-based provider of forklifts (and related components) is starting to pop up on my dividend screens more and more.

A general economic slowdown in 2008 led management to slash the payout, from $0.78 in fiscal (January) 2009 to just $0.12 in fiscal 2010. It now looks like management was being too cautious. The dividend is slowly being revitalized, to $0.27 in fiscal 2011, and a more recent hike in the quarterly payout to $0.25 implies an annualized dividend of $1. Still, that's a payout ratio of just 20%. Cascade is on track to earn $5 a share this year and perhaps $6 a share in fiscal (January) 2013 if the global economy rebounds a bit in the coming year. Even at $5 in EPS, assuming a 50% payout ratio, a $2.50 dividend would equate to a yield of 6.1% at current prices.

Columbia Banking System (Nasdaq: COLB)
This Tacoma, Washington-based regional bank has too much cash lying around and has been itching to put it to work. It's been able to acquire the assets of five failed banks in its region during the past year (in deals where the Federal Deposit Insurance Corp. assumes most of the liabilities and Columbia simply pays for the assets). But management is hard-pressed to find the big acquisition opportunities to help put its $1.3 billion in cash to better use.

Well, share buybacks and rising dividends may be the next best alternative. Columbia used to pay out about $0.60 a share in dividends, but the bank sharply slashed the payout in order to be eligible to receive funding from the Troubled Asset Relief Program (TARP) during the financial crisis. With the TARP loans repaid, the dividend is getting fresh attention. It was just $0.01 a share in the fourth quarter of 2010, but has been on the rise each quarter since and could hit $0.13 in the current quarter. By my math, the quarterly dividend could rise to $0.20 without leaving any real dent on the balance sheet. This equates to a 4.3% annualized yield based on the stock's recent prices.

Risks to Consider: The only way these dividends will be boosted is if the companies remain convinced that the reasonable economic conditions of 2011 (as seen by robust corporate profits) can be sustained into 2012. If that fails to materialize, then you might as well kiss the near-term possibility for a dividend hike goodbye and hope it happens later on.

Action to Take -->  You can either buy high-yielding stocks, or you can identify stocks that are currently lower yielders with the potential to become high-yielders. I like this idea, because it means you got ahead of the crowd and likely rode the stock higher in addition to receiving higher dividends over time. Remember: you're paying up for future dividend growth, so an investment today might be providing 10% annual dividend payouts five or 10 years from now.

Disclosure: Neither D. Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.  

This article originally appeared at www.streetauthority.com.