3 Dividend Stocks to Buy Ahead of the Fed

NEW YORK (TheStreet) -- The market is bracing for changes in policy at the Federal Reserve, which could announce a reduction in stimulus as early as next week, a negative for the stock market, as it suggests the Fed is prepared to allow the U.S. economy to start working on its own.

So, for those with longer-term investment horizons, it makes sense to move into more conservative investments that can weather the volatility likely to accompany the changing policy.

Valuations in the benchmark indexes continue to trade within striking distance of their record highs, and so safety stocks that are likely to perform best will be seen in companies that pay higher yields relative to industry counterparts. This approach helps screen out weaker companies unable to generate the profits needed to match those dividend payouts.These three dividend yielders should perform well, even if the Fed starts to wind down its bond purchases as expected.

What we are looking for in dividend picks is a strong payout record that is supported by the company's balance sheet. Here, we will look at three companies in strong positions in their sectors and likely to trade in a stable fashion even after the Fed begins to remove stimulus from the economy.

First, we look at the tech sector and Cisco Systems ( CSCO), a company that has drastically reduced spending and that is hoarding cash that can be used to sustain its dividends long term.

Cisco recently raised its quarterly dividend to 17 cents per share from 14 cents, and the company is likely to see growth from increased product purchases from telecoms and other outlets, as the broader economy continues to recover. Projected revenue growth of about 7% suggests that Cisco will continue to generate cash, as long as it maintains its margins.

From a valuation perspective, the stock is trading at a price-to-earnings ratio below 13, and when combined with the 2.8% dividend yield, the stock is an attractive prospect at current levels.

Next, we look at a stock that has taken a hit in the last few months in Mattel ( MAT), which should be interesting to contrarians. The toy maker is off more than 8% from its May highs, but with the Christmas season just around the corner and share buybacks getting the market's attention, these losses are likely to start reversing in the coming months.

Mattel is a strong cash generator and trades at 18 times earnings. When we combine this with the stock's 3.5% dividend yield, the picture looks positive.

The stock has been hurt by earnings weakness in the last two quarters. But with an improving outlook for consumer spending, earnings should start to gain traction as we head into next year.

Last, we look at Dow Chemical ( DOW), which has a steady payout history and has undergone some restructuring as the company sells off its lower-margin businesses. That has led to improved projections for Dow's margins, with falling debt and greater returns on invested capital.

Higher growth projections in Europe should help revenue in 2014, and the company's target for return on capital is 12%. If these projections are accurate, we could easily see a 10% gain in the share price, making the stock an attractive buy with its 3.2% dividend yield.

That all creates potential gains of more than 13%, which is excellent considering we are looking at a market with less support from the Fed.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is based in China, and has lectured at several universities there on international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of Web sites, including MarketBulls.net, Seeking Alpha, FX Street and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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