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An 11% Yield for an Aging Bull

May 31, 2011 – by Richard Band

We are two years into a bull market that has seen the S&P double, and I am concerned that we may be getting into the later innings of this ballgame for two reasons — one fundamental and one technical.

The fundamental reason is that values are getting stretched. I’m finding fewer and fewer stocks that can be considered bargains.

Technically, I’m concerned because, slowly but surely, I’m seeing more and more stocks that are falling by the wayside. At the beginning of the bull market, 90% or more of the stocks listed on the New York Stock Exchange were in confirmed uptrends. But now that number is closer to 75% to 80%. That’s a sign of an aging bull.

Now, generally, bull markets average about four years, and we’re two years into this one. And there are people like Laszlo Birinyi, for example, who believe this will be a mega bull market that will go on for quite a while. It would certainly be wonderful if that were true, but I suspect that we’re in an environment more like that of the 1930s or 1970s.

The move off of the low in 2009 has been accompanied by weak fundamentals — high unemployment, low job creation and financial institutions with a lot of bad loans still on their books. So this doesn’t feel to me like a bull with a long lifespan ahead of it.

However, I do not recommend that people sell everything. I’m not an all-in-or-all-out type of guy. I don’t think that kind of market timing works for most people. In the later stages of a bull market, I think it’s important to focus on defensive stocks that pay now in the form of high yields, so I’m looking at dividend stocks like Raytheon (NYSE: RTN).

Raytheon is one of the largest defense contractors, and it’s throwing off tremendous amounts of free cash flow. If you looked at the company’s free cash flow, which is the cash flow after all capital expenditures have been deducted, the free cash flow yields about 11% of the stock price. That’s very cheap when you consider that 10-year Treasury bonds are yielding a little over 3%.

And while investors are anticipating some cuts in the defense budget, Raytheon has been diversifying. It’s still a big missile producer, and but it’s been diversifying into things like cyber security and border security. In doing this, RTN is expanding international sales, making it less dependent on the U.S. Department of Defense. This is not widely known on the Street, and that’s why I’m buying this dividend stock.