Course 407:
High-Yield Stocks
In this course
1 Introduction
2 What Is the Company's Dividend Track Record?
3 Is the Payout Ratio Rising?
4 Are the Company's Sales and Earnings in Line and Stable?
5 Does the Company Generate Consistent Free Cash Flow?
6 Is the Balance Sheet Healthy?
7 How Has the Stock Performed?
8 Is This Stock Expensive Relative to Others in Its Industry?
9 Conclusion: Looking Both Ways

High-yield stocks are like the little engine that could. With dividend yields that are at least twice that of the large-cap average, these stocks are a far cry from capital-gains-charged growth companies. Instead, by paying a solid dividend year in and year out--and with a little push from the power of compounding--these stocks can add incrementally to performance, eventually piling up a mountain of returns. There are reasons besides income to hold these stocks. For one, they generally have low valuations, largely because price appreciation and yield are inversely correlated: If a stock's price rises, its yield falls. Their relative cheapness can make high-yield stocks defensive plays during a bear market, lowering the overall volatility of a diversified portfolio. In the last three months of 1987, when the S&P 500 suddenly lost one fourth of its value, the S&P Utility index--a proxy for high-yield stocks--was a relative haven, falling only half as much. High-yield stocks don't offer much in the way of growth, though. These companies have made a choice to pay out a good portion of their profits as dividends rather than plow the money back into expansion. As of the end of 1999, the high-yield companies in Morningstar's database had an average EPS (earnings per share) growth rate of 7% over the previous three years, about half the growth rate for the S&P 500. Tobacco and food conglomerate Philip Morris MO is a good example of a high-yield stock. Its dividend yield of nearly 7% (as of late 1999) is in the top quarter of all the stocks in the high-yield stock type, and its revenue and earnings growth have been slow but relatively steady. After several years of healthy gains, Philip Morris' stock has recently stumbled because of fears about the cost of tobacco litigation. The following are some questions that are worth asking about high-yield stocks in general, with answers as they apply to Philip Morris in particular.

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