When choosing stocks to buy, some investors focus heavily on the potential for capital gains, the increase in share value due to a rise in price.
Although this is an important metric and has gained attention during what has become an enduring bull market such gains are subject to the whims of market shifts. Another avenue for income-potential is through dividends periodic -- typically quarterly -- payments to shareholders that represent a portion of a company's profits.
The search for dividends, however, is more involved than picking a Chance card on the Monopoly board. Bigger isn't always better, and just because a stock has a high dividend yield -- annual dividend divided by share price -- that doesn't necessarily mean that it is a better investment than one with a lower yield.
For example, the dividend yield could increase if a stock price drops, which could be a red flag for financial struggles in the underlying business.
A company's payout ratio, which is the relationship between what it pays to shareholders and how much profit it generates, is another key metric. Too high a payout ratio could limit a company's ability to buy back shares, build the underlying operation or raise dividends.
A healthy dividend is one that will grow over time and provide a solid stream of income for the investor.
In his stock market bible, The Intelligent Investor, the legendary value-investor Benjamin Graham wrote: "Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies."
Last year, a Motley Fool article on dividend investing stated, "Although the past can't always be relied upon to predict the future, that tends to be the case for dividend stocks. If a stock has a rock-solid record of increasing its dividend, then odds are the pattern will continue. Conversely, if a stock has a lousy record that includes dividend cuts, that may be a red flag that the dividend is vulnerable to dips in the market and the economy."
Investing guru James O'Shaughnessy, whose strategies served as inspiration for one of our stock-screening models, thought that large companies with high dividends as well as solid cash flow, outstanding share levels and top lines tended to be good value investments.
Using our Guru Stock Screener, here are five picks with dividend yields exceeding 5%. All the stocks on the below not only carry high yields but also have price appreciation potential, so investors could get a double benefit from being selective and thinking like a value stock picker when looking at these names.
Guru Strategy By or About
Joel Greenblatt model
Benjamin Graham & Greenblatt models
James O'Shaughnessy model
Waddell & Reed Financial
Peter Lynch & Graham models
Lynch and O'Shaughnessy models
1. GameStop (GME) - Get Report
This video game retailer earns a perfect score under our Joel Greenblatt-inspired investment model based on its earnings yield of 21.59%, coupled with a return-on-total capital of 80.11%. Together, these criteria place the stock third among those in our database.
Our Peter Lynch-inspired screen also favors GameStop due to the relationship between the stock's price-earnings ratio and growth in earnings per share, based on three-, four- and five-year averages. This quotient, referred to as the PEG ratio and an earmark of the Lynch strategy, is quite favorable at 0.45, with the maximum allowed of 1.
The dividend yield is strong compared with the S&P 500 of 2.28%). Our Kenneth Fisher-based strategy also favors GameStop, given its price-sales ratio of 0.30, well below the maximum level allowed of 0.75.
Free cash flow per share of $3.09 adds appeal.
Our Graham-based stock screen favors the level of sales, which were $2.58 billion, based on trailing 12 months, as well as the company's current ratio of 2.62, versus the minimum requirement of 2. Earnings per share have grown tremendously over the past 10 years, well above the required 30%, and the P/E ratio of 5.28 is considered moderate under this model, which sets a maximum of 15.
Our Greenblatt-based strategy likes the company's earnings yield of 14.04%, coupled with its return on total capital of 44.01%.
The company is in the process of settling the case alleging its sale of misbranded dietary supplements. GNC Holdings admits no wrongdoing, and the agreement affirms that the company was in full compliance with regulations governing the sale of the products in question.
It earns a perfect score under our O'Shaughnessy-based investment strategy, due to its strong cash flow per share of $9.77, versus the market average of $1.47, and trailing 12-month sales of $81.65 billion are nearly four times the market average. Our Fisher-based screen likes the company's price-sales ratio of 0.54, which is well below the maximum level allowed of 0.75, which indicates good value.
Free cash per share of $2.97 and a three-year average profit margin of 5.93% add interest.
4. Waddell & Reed Financial (WDR) - Get Report
This asset management and mutual fund company scores highly under our Lynch-based screen based on its strong PEG ratio of 0.51. This model uses an equity-assets ratio to gauge the underlying strength of a financial services company, and Lynch considered it a better metric than the debt-equity ratio.
Waddell & Reed Financial's equity-assets ratio of 60% is stellar compared with the minimum requirement for this model of 5%, and the stock's return on assets of 13.29% is also considered impressive, with the minimum requirement at 1%. Our Graham-based methodology favors the company's liquidity, with a current ratio of 3.57, versus the minimum requirement of 2, and there has been significant growth in earnings per share over the past 10 years.
The price-earnings ratio of 9.38 is viewed as moderate by this model, with the maximum allowed at 15.
Our O'Shaughnessy-inspired investment strategy likes the company's top line, with sales of $105.70 billion representing well over 1.5 times the market average on a trailing 12-month basis. Our Lynch-based screen favors the company's PEG ratio of 0.59, versus the 1 maximum, and the equity-assets ratio of 8%, which exceeds the minimum of 5% required under this model.
At the time of publication, John Reese and/or his clients were long all five stocks mentioned in the article, AZSEY, GME, GNC, LUKOY and WDR.