A Growth and Income Machine

That's the idea behind our Not Just Income screen. Dividend yields of 2% or so (the S&P 500 index yields about 1.8% right now) aren't going to make anyone rich. So why run a dividend search that focuses entirely on fat yields? Better to run a search for solid growers with cheap shares, and tack on a modest dividend requirement as a sweetener.

The emphasis here is on a modest dividend requirement — we look for yields greater than 1%. It's not about the money (although we'll certainly take it). It's about the mentality. Managers that commit their companies to dividend payments show that they understand the importance of returning capital to shareholders.

Believe it or not, the last thing a shareholder wants to see is cash piling up on a company's books. Managers, research shows, are awful cash stewards. Surplus funds that don't go toward dividends, debt reduction or share repurchases are more likely than not to be spent on what academics call "empire building." That's the tendency of cash-rich managers to reach for shiny new acquisitions in order to extend their influence — often at the expense of their shareholders.

In addition to the dividends, our screen looks for plenty of promising financial indicators. Each company must have increased its sales and earnings by 15% apiece in the past year, and be projected to grow its earnings by 15% annually over the next five years. Each must pay out less than 50% of its earnings as dividends, ensuring that they can continue to afford the payments. And each must have a price/earnings-to-growth, or PEG, ratio below 1.5. That's a sign that their share prices are low relative to both their earnings and the rate at which those earnings are projected to grow.

Use our stock screener and Not Just Income recipe anytime to run our search for yourself. Recently it produced a list of 12 names, among them, Regal-Beloit.

Based in Beloit, Wis., Regal-Beloit makes electric motors, power generators, switches, gears, gear boxes and more. End products that use its components include refrigerators, air-conditioning systems, cars and exercise equipment. Trailing 12-month sales for the company total $1.1 billion, up from $628 million at the time of our last story.

A healthy chunk of that increase came from a pair of acquisitions Regal-Beloit made last year. But absent the buys, sales would still be moving in the right direction; the company's second-quarter results, reported July 26, showed sales, ignoring acquisitions, climbing 9% year-over-year. Including acquisitions, sales swelled 108% to $368.8 million. Earnings jumped 142% to $18.4 million. Per-share earnings of 62 cents missed expectations by two cents. Investors said "close enough." Shares have gained a point or so since the announcement.

"The company is in a strong position to take advantage of the recovering industrial economy," wrote Morgan Joseph analyst Richard Rossi in a research note issued the day of the earnings release. "The two acquisitions completed last year provide important new products, add a broader after-market business as well as an additional customer base, and expand geographic reach. These acquisitions also provide significant, highly efficient global manufacturing capacity and add to RBC's technological capabilities." (Rossi doesn't own shares of Regal-Beloit; Morgan Joseph doesn't have an investment-banking relationship with the company.)

Speaking of increased capacity, the company's cash position has doubled to $29.2 million over the past quarter. But it looks like the money will be spent wisely. The company increased its dividend in June (to 13 cents a quarter from 12 cents, recall). Long-term debt has more than doubled year-over-year to $536.9 million due to the acquisitions, but has been trimmed by $11 million since the beginning of the year.

In short, the growth is there and the prudent cash management is there. So what about the valuation? Shares trade now at less than 15 times projected 2005 earnings. The average price/earnings ratio for makers of machines and components is 21. And Regal-Beloit is expected to boost its earnings by 21% annually over the next five years, faster than the group's 15%. That gives its shares a PEG ratio of about 0.7, half the average for its peers and well lower than the S&P 500's PEG of 1.6.

Of course, the dividend yield now amounts to a ho-hum 1.6%. Such, unfortunately, is the plight of income stocks whose shares prices refuse to stop rising.