The Technology-driven U.S. equity rally has continued in 2019, despite a lot more “chop” in the indexes, including another -10% correction in tech names this past May. While the debate rages on about when the U.S. equity bull market (bubble) will end, we have learned not to be too dogmatic on picking the ultimate top or guessing which pull-back will keep going. For our portfolios, we feel that the best strategy is to both avoid moving into already crowded trades (such as the QQQ) and to make sure that your stock holdings are paying you while waiting for renewed investor inflows.
We have been cautious on the broad indexes due to the high weighting of the over-valued tech sector. However one sector is beginning to look attractive from a relative point-of-view — Retail. Of course, retail is not historically a late-cycle play but (1) this a not a normal business cycle and (2) there is no use in underestimating the will of the Powers-That-Be (Federal Reserve, Trump, big banks) to stave off recession even longer. Should recession hit in 2019-2020, currently not expected by the Street, retailers any not likely to be a safe-haven.
With that caveat, we are looking at high dividend names in the retail sector. As the S&P 500 and Nasdaq charged to record highs again in 2019, the S&P Retail Index (XRT) has hardly participated. The underperformance of retail is visible in our chart of retailers relative to the S&P 500 below.
It would appear that retailers are under-owned in portfolios given this massive under-performance over the past few years. Whether the S&P 500 is set to continue rising or begin falling, sector rotation will continue to characterize the market. In this spirit, buying under-owned / out-of-favor sectors and lighten up on crowed sectors like tech makes good sense from a portfolio allocation point-of-view.
We like two retailers that are offering attractive entry points, obtain high scores in our WMA fundamental rankings, and pay healthy dividends. The first name is American Eagle Outfitter (AEO) and the second is Macy’s (M).
In our methodology, we choose dividend-paying companies for three reasons, aside the juicy dividend. Most dividend-seeking investors should also be concentrating on these three company characteristics.
- The ability of the company to continue paying the healthy dividend, or what we call “regularity”.
- A small likelihood of the company having financial problems, or what we call “solidity”.
- A low chance of seeing the company’s share price experience a significant draw-down, or what we call “low volatility”.
In evaluating / choosing Yield companies for our portfolios, we check all of the above boxes before recommending a Yield company for our clients. In our fundamental ranking methodology, we have developed metrics to address each of the above characteristics, which we explain throughout this article. Note that each company is ranked on a scale of 0 (weakest) to 100 (strongest) for each fundamental metric.
American Eagle Outfitters (AEO)
American Eagle offers a quarterly dividend $0.55/ share (or 3.16%, about 125 points above the S&P 500 yield). AEO would be qualified as a contrarian play today, looking at the recommendations of analysts on the Street. According to our WMA Global Rankings, the analyst consensus score on American Eagle is 58.0, placing AEO in the bottom 35% of the 5,200 companies that we track. Analysts are citing headwinds such as the widening spread between elevated inventories and sales growth for their pessimism.
We are less concerned about previous quarter headwinds, which are now well-known and should be in the price of AEO. American Eagle was recently -43% off its 2018 highs.
Revisions for current and next year earnings per share (EPS) and revenue estimates have stabilized. Over the past month, EPS revisions have actually ticked up, with our 1-month EPS Revision score at 51.2 (a score of 50 corresponds to 0% consensus change in EPS estimates). This places American Eagle in the top 75.8 percentile among the 625 Consumer Discretionary stocks we track.
Profitability and stable-to-growing earnings, as exemplified in our Revisions scores, make up our evaluation of company “regularity”. When buying a Yield company, investors want to make sure that the company will be able to continue paying the dividend going forward. In our ranking summary table for American Eagle, we see that AEO’s profitability is satisfactory, with a score of 65.5 (a score of 50 defines a 0% combined profit margin and EBITDA margin).
Next, as for solidity, the Financial Situation score gives us no worries. AEO has one of the soundest balance sheets in the Consumer Discretionary sector with a score of 93.3. Investors have little risk of a permanent impairment in American Eagle.
The third fundamental box we check with Yield companies is volatility. Our Risk Score for American Eagle is a moderate 2. Our Risk scale ranges from 1 (least risk) to 5 (most risk) and describes an aggregate of numerous variables (beta, standard deviation, distance from 40-week moving average and our 52-week CLV score). For Yield companies, we are more comfortable keeping the risk at 3 or below.
Finally, the price chart of American Eagle is constructive. We see a price pull-back under-cutting the late 2018 low, but reversing higher on a positive divergence with most oscillators (see our chart with the stochastic below). We judge this to be a good entry point into American Eagle.
In sum, barring a sudden dip into economic recession, we’ll be holding American Eagle for a bounce over the coming quarter(s) while enjoying the dividend.
Macy’s pays a quarterly dividend $1.51/ share (or 7.01% dividend yield). Macy’s delivered an $0.11 1Q EPS beat on lower taxes and $43M in real estate gains. This earnings beat was not enough to slow the stock’s price down-trend in place since August 2018. Again, this pick is another contrarian dividend play. Macy’s is disliked by analysts. Our Consensus F-score is currently at 39.5, scrapping the bottom of our global rankings in only the 5.4 percentile.
Once again, the pessimism seems to have been priced into Macy’s stock. Our 6-year chart shows the extent of the damage, with Macy’s -51% off its 2018 highs.
Macy’s checks the boxes for forwarding-looking EPS estimates, our fundamental evaluation of the company, and upside potential of the stock price. We therefore have a Buy on Macy’s.
Revisions for current and next year earnings per share (EPS) and revenue estimates are turning higher. Over the past month, EPS revisions have jumped, with our 1-month EPS Revision score at 55.7, or 78.6 percentile among all retailers.
Profitability is positive (above 50) buy only in the 41.3 percentile among retailers. We’ll need to see earnings pick up to keep Macy’s as a long-term position.
Next, the quality of Financials is middle of the pack at 50.0, not great but good enough to get us excited about the upside price potential. We have a bit more concern about Macy’s business relative to American Eagle, but again, no financial accident is foreseeable.
Our Risk Score for American Eagle is a neutral 3. Macy’s carries more risk than American Eagle, but we see more price upside and a higher dividend as the compensation for this risk.
In sum, we like Macy’s for its 7% divided, a glimmer of hope in our 1-month EPS Revisions score and beaten down stock price. We will not add to losing positions if price continues to fall below $20.
Rightly or wrongly, retail is an out-of-favour sector currently in this bull market. Value investors seeking dividends should look to American Eagle and Macy’s to earn yield while waiting for sector rotation back into retail.