5 Dividend Picks from Value Investing Legend

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Financial stocks had a remarkable year in 2012. Based on the Financial Select Sector SPDR (NYSEARCA:XLF), financials were the best performing sector last year, returning 23.4%. Despite the broad sector’s rally, some financial stocks remain undervalued. With growth prospects of the sector expected to improve in 2013, financials are likely to extend their gains further. The greatest potential for market-beating returns over the medium term have value stocks that pay high dividend yields.

Chuck Royce

Following value investor Chuck Royce’s disciplined value approach to stock selection, investors can identify plenty potential picks to achieve strong income and a value tilt in their portfolios. Based on Royce’s selection of financial stocks that comprise his namesake Royce Dividend Value Svc (MUTF:RYDVX), here is a list of five high-yield financials for 2013. These are high-yielding stocks that among Royce’s financial sector picks hold the largest shares in the noted fund.

KKR & Co. L.P. (NYSE:KKR) is a global private equity firm. Its stock has gained 17.4% over the past 12 months. The partnership’s yield is 6.2% and its payout ratio is 34%. Its distributions in 2012 were 18.3% higher than in 2011. The latest quarterly cash distribution was almost double the combined distributions of the previous two quarters. Nearly two thirds of the latest quarterly distribution came from carried interest, the partnership’s share in the funds’ profits. In fact, according to an Oppenheimer analyst, in 2013, KKR should have “a higher percentage of its private equity assets under management in a ‘cash carry’ mode than most of its peers.” Thus, distributions increases can be expected. KKR’s private equity funds gained 20% and its balance sheet investments added 22% in the first nine months of 2012 over the same period a year ago. The partnership is diversifying into credit, real estate, and hedge funds. Trading at 5.3x trailing and 6.8x forward earnings, KKR is cheaper than its peers. The partnership is popular with Arial Investment’s John Rogers.

Federated Investors Inc (NYSE:FII) is an asset manager offering a broad range of income-oriented funds. FII has rallied 34% over the past 12 months. Its dividend yields 4.5% on a payout ratio of 57%. Its regular dividends grew, on average, by 6.8% annually over the past five years, but the quarterly payout has been flat at $0.24 per share since 2008. In November 2012, the company paid a special dividend of $1.51 per share. FII’s long-term annual EPS CAGR is forecasted at 6.5%. Recently, the company has been surprising to the upside. Still, some concerns remain about the possible adverse impact on FII’s operations from the long-heralded money market reform that will aim to emphasize to investors the risks inherent in investing in money market funds. There are concerns investors will avoid money market funds, putting their money into banks. Federated receives 40% of its total revenue from money market funds. In terms of valuation, FII has a price-to-book below its historical averages. It is attractive based on the forward P/E of 11.6x, representing a 20% discount to its peer group. Fund manager Tom Gayner (Markel Gayner Asset Management) is a buyer of this stock.

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