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Sunday, March 6, 2011

Caterpillar’s Price Target Boosted at Jefferies & Co. (CAT)

Construction and mining equipment maker Caterpillar Inc. (CAT) on Wednesday saw its price target boosted by analysts at Jefferies & Co.

The firm raised its target on CAT from $110 to $120, suggesting a 20% upside to the stock’s Tuesday closing price of $99.86. That change came after the company’s recent investor meeting in Texas.
Jefferies also maintained its “Buy” rating on CAT, noting positive market trends and the company’s positive recent guidance.

Caterpillar shares fell 63 cents, or -0.6%, in premarket trading Wednesday.

The Bottom Line

I have been recommending Caterpillar (CAT) as an aggressive dividend recommendation since Dec.7, when the stock was trading at $89.20. The company has a 1.76% dividend yield, based on last night’s closing stock price of $99.86.

 Disclosure I am long CAT shares.

What is a Good Dividend Yield?

Dividend yields have a bit of a "Goldilock's porridge" quality about them. Investors have to try different yields while searching for the ones that are just right. Pick one that's too low, and you'll be risking your money and not getting paid for taking on that risk. But pick one that's too high and you could get seriously burned.

Too Low

Investors love dividends. And they have every reason to. A dividend can be, among other things, evidence that a company is:
  1. financially secure; 
  2. confident about future sales trends; and 
  3. willing to share that stability and success with it's shareholders
But just paying any old dividend doesn't automatically qualify you as a good dividend stock.

Consider the case of Halliburton (NYSE:HAL), an oil and gas company with a market cap of over 40 billion. Halliburton's current yield is 0.75%, which is less than what you can get from a 2 year U.S. treasury bill. One of these investment options is backed by the full faith and credit of the U.S. government, and the other one is not (probably).

To qualify as a good dividend yield, it has to compensate investors for the extra risk of owning stocks instead of bonds or bank CDs, so the yield shouldn't be too low.

Too Steady

Consistency is a prized value in dividend stocks. So much so that the S&P 500 has a special class of dividend payers called dividend aristocrats which have raised dividends for at least 25 consecutive years.

But consistency can cut both ways. Take a look at Merck (NYSE: MRK), a pharmaceutical company with a mega-market cap of over 100 billion. It currently sports a hefty yield of over 4.5% which is no small potatoes when 10 year treasury bonds are paying around 3.75% and most bank savings accounts are at less than 1%.

But as with so much of investing, the important aspect of the dividend yield is all about the future, not the present. And that's where Merck comes up short. The company has been paying the same exact dividend for over six years, without a single hike since September of 2004! That's not the kind of consistency that dividend investors hope for. To qualify as a good dividend yield, it has to be growing.

Too High

In early 2008, Harley Davidson (NYSE: HOG) had a dividend yield of $0.33 per share, or over 6%. Investors who were selling Harley stock for fear of what the recession would do to motorcycle sales were right to keep the stock price down, and the dividend was slashed by 70 percent in the next quarter!

To be a good dividend yield, it must be sustainable and shouldn't be temporarily inflated by a low stock price. In other words, it shouldn't be too high.

Just Right

That puts the sweet spot of dividend yields these days at around 3-5 percent. There are plenty of large cap companies paying dividends in this range which have been raising their dividends over the last five years. Running a screen for these metrics yielded about 40 stocks for me. Here are a few picks from the bunch:

Unilever (NYSE: UL)
Market Cap: 84 Billion
Yield: 4.75
Dividend Growth Rate (5 year average): 17%

McDonald's (NYSE: MCD)
Market Cap: 80 Billion
Yield: 3.21
Dividend Growth Rate (5 year average): 29%

Clorox (NYSE: CLX)
Market Cap: 9 Billion
Yield: 3.23%
Dividend Growth Rate (5 year average): 14%
Disclosure I am long CLX, MCD and UL shares.