Personal Finance

Dividend stocks that could yield big returns in 2015

The key to high dividend stocks: Sustainability

Are you looking for solid returns with low risk in your portfolio this year? Of course you are. And investment pros have just the thing for you: dividend-paying stocks.

Dividend growth, estimated by FactSet at 10.5 percent for the S&P 500 for 2014, is expected to be slightly less robust in the coming year, at 8 percent, according to John Butters, senior earnings analyst. Still, there are sectors and stocks that fund managers expect to shine, generating double-digit total returns thanks in large part to their dividends.

"Companies in the U.S. still have very good balance sheets and good cash generation, and dividend payouts are still below the average of the past 50 years," said Brian Hennessey, portfolio manager of Alpine's Dynamic Dividend Fund, who is among those anticipating dividend growth in the high single digits.

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Whither interest rates?

One big question facing dividend fund managers is what to do about REITs and utilities, since they performed so well in 2014 and could be vulnerable to an interest rate hike. But Hennessey takes a different view. He believes that 10-year bond yields below one percent in several relatively robust European countries, such as Germany, Switzerland, Sweden, France and the Netherlands, will keep upward pressure off of U.S. rates.

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That makes him more comfortable with REITs than some other portfolio managers. For example, Hennessey likes The GEO Group, one of two publicly traded prison REITs. He believes the private prison business is a good one, and that GEO is undervalued relative to comparable health care-related REITs. He also likes GEO's 6 percent yield.

Hennessey also likes Two Harbors Investment, a mortgage REIT, pointing to a conservative balance sheet and a valuation below book value. He thinks Two Harbors should trade at book value and, even without any appreciation, it offers a 10 percent dividend yield.

Bullish on big companies

In contrast, Josh Peters, director of equity income strategy at Morningstar, is wary of REITs and utilities, for the most part. He does, however, like Public Service Enterprise Group, the New Jersey utility, and the company's shift toward the steady, regulated part of the business, as opposed to wholesale generation. "My only qualm is valuation, and it's certainly not unique to them" among utilities, Peters said. Nonetheless, he plans to hang on to the stock.

Peters also likes and holds some big multinationals, such as General Electric, which has faced headwinds because of its exposure to the energy sector. Chief Executive Jeffrey Immelt's strategy of slimming down the company's financial services operation and building up its industrial and infrastructure businesses is well known, but Peters believes investors have yet to wake up to it. He thinks the stock is currently worth $30 on the basis of Morningstar's long-term forecast, a sizable premium to the current price, and the yield at about 3.8 percent is also attractive.

Coca-Cola is another global player Peters is somewhat bullish on.

"Far and away the biggest headwind to earnings is currencies," he said. "I don't know when it's going to turn around, but eventually it's going to." In the meantime, Coke has its global distribution channels, usable even as consumers' tastes shift. Peters does not expect a big dividend increase this year, and he currently views the stock as "a little expensive," but over the long run he expects 7 to 8 percent dividend and earnings growth.

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Altria is another Peters holding. Currency exposure is less of a concern for the company, he said, and cash flow is steady. The tobacco names, he said, "have functioned and acted like the utility stocks." But when the interest rate environment shifts, he warned that "at some point the capital appreciation potential disappears."

Entry point for energy

Not all dividend-focused investors pick stocks. Jay Jacobs, a research analyst at Global X Funds, falls in the camp that does not.

Global X offers three dividend-focused ETFs, which currently have a high allocation to financial services, including REITs, Jacobs said. REITs are still yielding well above the S&P 500 average, he pointed out, and "you can still find REITs that are yielding 6 or 7 percent." Companies in the consumer discretionary sector have also produced high yields, Jacobs said.

At the moment, he has his eye on the energy sector. Given the dramatic drop in oil prices, he said, "A lot of people are talking about the value pick of energy right now; a lot of people are looking at the energy space for an attractive entry."

As for dividend growth, Jacobs is watching the information technology sector. It has not been known for big payouts in the past, which means a high-dividend growth rate could be achievable. "You are [also] seeing the maturation of a lot of companies," he said, pointing to Apple's initiation of dividend payments in its fiscal 2013.

The bottom line: Look carefully for dividend opportunities in 2015, and your search could yield handsome returns.

Disclosure: Alpine's Dynamic Dividend Fund has positions in The GEO Group and Two Harbors Investment.