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The Safety TrapBy Larsen Kusick, analyst, Phase 1 InvestorMonday, August 2, 2010 "Boring" stocks are hot right now.
If you don't believe me, check the 52-week high lists. Utilities, pipelines, and tobacco stocks appear on a daily basis.
Investors aren't just grabbing for the big dividends these sectors pay. They're piling into companies with super-predictable earnings. Considering the horrid state of the housing market and zero real job growth, you can't blame them for seeking out the low, consistent levels of earnings "boring" companies provide.
It's the "safety trade." And right now, the safety trade is crowded...
Don't get me wrong, many pipeline and utility firms are good choices for an investor's portfolio. But consider that blue-chip pipeline company Kinder Morgan is up 34% in the past year. Marlboro maker Altria has generated a 35% return.
With stocks like these up so much, you're overpaying for safety right now.
For example, the recent strong performance of utilities has pushed valuations above normal levels. Over the past 20 years, utilities have traded at an average 15% discount to the S&P 500, based on price to forward earnings. Currently, the sector trades in line with the S&P – meaning there is no discount.
Maybe utilities aren't wildly overvalued right now. But they're no bargain. And they're hitting new highs while posting better-than-expected results. As an investor, you want to be buying before that happens, not after. Safety is best bought when most people shun it... not when most people have already piled in.
And investors have piled into pipeline stocks. If you own Kinder Morgan, you're up more than 60% in 18 months. The benchmark Alerian pipeline index is up 40% in the last 12 months.
This super performance means yields have fallen. My colleague Tom Dyson, who writes the income-focused 12% Letter, prefers to buy these stocks when they're paying 10%. Right now, they're paying about 6%.
If you're looking for safety and yield, there are better, cheaper opportunities right now...
Consider my colleague Frank Curzio's take on Chevron... or Matt Badiali's take on ConocoPhillips. Both companies are cheap, trading for less than 10 times forward earnings, and both offer dividends of 4%. Granted, those aren't huge current dividends, but those dividends can grow.
If you've enjoyed a good run in the "safety trade," congratulations. But it's time to start looking at cheaper ways to pick up yield.
Good investing,
Larsen
Further Reading:
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Malaysian fund (EWM) hits new high... Southeast Asia is booming.
Ugly month for gold and dollar... both drop more than 5% in July.
Ag uptrend... Monsanto, Potash, Mosaic rise more than 20% this month. Tractor maker Deere hits fresh 52-week high.
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