This Cheap Stock Yields 4.5% (and Could Soon Pay More)

Welcome to the club, Goldman Sachs (NYSE: GS)!

[Last] Friday, the global investment bank predicted looming dividend tax hikes would soon create “a wave of special dividend announcements” amid a “perfect alchemy to reward shareholders.”

The firm pointed out that corporate America’s flush with cash, with gross non-financial cash rising by 55% since 2007.

This should all sound eerily familiar. Back in August, I predicted the same thing:

I’m convinced companies are going to start paying out another round of dividends this year… or “fifth quarter” dividends, if you will.

They can certainly afford it, given their record cash balances and profitability. Or as Standard & Poor’s Howard Silverblatt notes, an extra dividend “should have only a minor impact on their year-end ratios and liquidity.”

[ad#Google Adsense 336×280-IA]I’m not writing today for bragging purposes, though.

Being the first to come up with an idea doesn’t put more money into my investment account.

Or yours, for that matter.

The only thing that does is coming up with good investment recommendations, which is what I’m focused on today…

You see, Goldman also issued a list of 15 companies with the potential to pay out special dividends by the end of the year.

I don’t know about you, but I don’t exactly have enough excess capital lying around to purchase 15 new stocks. Even if I did, I wouldn’t recommend buying blindly into Goldman’s list of companies. So what I’ve done is whittle down the list to the single most attractive opportunity – Federated Investors (NYSE: FII).

How’d I do it? I used a straightforward and rational approach, with a keen focus on reducing our risk and maximizing our yield…

First, I ruled out any stocks yielding less than 2%. Why? Because there’s no guarantee any of these companies are going to actually pay a special dividend. In the event they don’t, we want to make sure we’re still getting paid. By writing covered calls against these stocks, we can easily double or triple the payout, too.

Second, I insisted on insider ownership of 10% or more. Call me crazy, but I believe many individuals are self-serving. And the incentive for management to pay out a special dividend is much greater if they’re going to directly benefit, too.

Third, I eliminated any expensive companies, ones trading at a premium to the S&P 500 Index on a forward price-to-earnings ratio. After all, we shouldn’t overpay for the possibility of a special dividend. Instead, we should focus on opportunities where we stand to benefit from capital appreciation, too.

Lastly, I looked for patterned behavior – companies that paid out a special dividend the last time investors were faced with the threat of a dividend tax increase, which was at the end of 2010.

As Goldman notes, “Indeed, 2010 saw the highest number of one-time dividend announcements, more than double the run-rate of 2000-2011 period.” It stands to reason that the companies compelled to pay a special dividend last time will be compelled to do so again.

Guess what? Federated is the only company that survived all my screens. You might think that’s an indication of too much selectivity. I consider it being cautious, which is precisely what we need to do when investing in special situations. We need to think about the potential risks first, then the potential rewards.

Even if Federated doesn’t pay a special dividend, we’ll own a cheap stock that pays an above-average yield of 4.5%. In other words, it’s a win-win situation.

Safe investing,

Louis Basenese


Source: Dividends and Income Daily