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Choosing Dividend Stocks: Six Steps For Finding These Safe, High-Yield Investments
by Louis Basenese, Small Cap and Special Situations Expert
Friday, January 22, 2010: Issue #1181
The latest tally from famed professor, Jeremy Siegel – author of the investing classic, Stocks for the Long Run - proves that dividend stocks are still the best investment. Period.
Yet everyone still loves to dog them for being boring and slow growers.
Big mistake.
Let me prove to you just how profitable dividend stocks can be – and then show you how to find the safest, highest-yielding investments in this market.
How a 3.7% Gain Means An Extra $370,000
In his study, Professor Siegel sorted the S&P 500 stocks by dividend yield, dating back to 1957, and recorded the return of the top 100 dividend-yielders versus the bottom 100 for each year.
The result?
Investing in the top yielders delivered an annualized average return of 12.5%, compared to an average return of 8.8% for the lowest yielders.
Now, a 3.7% difference might not seem like much. But if you started with a $1,000 portfolio and reinvested all the dividends, it would be worth $450,000 today. That compares to only $80,000 without the extra 3.7% pop.
So if you’re serious about making money – and I suspect you are – dividend-paying stocks are essential to your portfolio.
But how do we go about finding safe, dividend-paying stocks in this market?
After all, companies keep slashing dividends by a record amount. From 2007 to 2009, total dividend payments slumped by $72 billion – the worst decline in over 50 years.
Six Steps to Finding the Best Dividend-Yielding Stocks
When looking for the best high-yield dividend stocks, the simple answer might sound a bit backwards: Don’t chase yield.
This is because a high yield typically indicates that there’s a higher risk of the dividend being cut or – even worse – being eliminated altogether.
Instead, focus on companies with the following six characteristics:
- Simple Business: The fewer moving parts, the fewer things that can go wrong, thus sapping cash intended for dividend payments. So focus on companies with businesses that you understand, rather than massive corporations that have dozens of (often puzzling) operating segments. That means shunning companies like General Electric (NYSE: GE) and its countless divisions, and instead going for companies like Philip Morris (NYSE: PM), which only does one thing and kicks back a $2.32 per share annual dividend (a 4.6% yield).
- Steady Demand: After identifying companies with simple business models, the next step is to verify that there is demand for the product(s). After all, a company needs a steady stream of cash, so it can afford to pay dividends to shareholders. Stick to industries or sectors with recession-proof or recession-resistant demand (food, alcohol, tobacco, healthcare, etc.)
- Cash Flow Positive: If a company isn’t generating cash each quarter, the only way to pay a dividend is by borrowing or tapping into cash reserves. Such practices aren’t sustainable over the long-term – and the dividend will eventually be cut.
- High Cash Balance: Speaking of cash… it’s still king. Especially when it comes to maintaining a dividend. Consider it insurance against any unexpected slowdowns. At a minimum, insist on enough cash to cover one quarter’s worth of dividends.
- Minimal Need for Credit: Securing credit in this market is extremely difficult. Accordingly, I recommend focusing on companies that don’t need to raise significant amounts of capital. That’s because when interest rates rise, so will their interest payments. I also suggest you look at companies with a reasonable, or low debt load. This ensures that interest payments won’t sap money intended for us.
- Earnings Buffer: Insist on a dividend payout ratio (annual dividends divided by annual net income) of 80% or less. This will provide ample wiggle room for the company to pay the dividend in the event of an unexpected slowdown. Or even better, to justify raising the dividend.
Three Profitable Dividend Stocks to Buy Now
After enjoying a hearty rebound in 2009, don’t be surprised if dividend investing starts attracting the herd in 2010. Many didn’t fully participate in the rally and now are undervalued, so they represent a safe way to invest in stocks.
Add in the fact that Treasuries still sport record-low yields and corporate bonds have already enjoyed a historic rally… and dividend stocks become even more attractive.
So I recommend that you front-run other investors. And the time to do that is now.
I’ve covered several suitable and safe dividend stocks in previous Investment U columns. In addition to Philip Morris that I mentioned a moment ago, you should also consider…
- Windstream Corp. (Nasdaq: WIN), which sports a $1 per share annual dividend (9.2% yield).
- Lorillard (NYSE: LO), which pays a hearty $4 per share annually (5.2% yield).
All three stocks remain attractive at current prices.
But that’s just an appetizer. If you want a consistent stream of dividend-yielding stocks, I use the six-step strategy above to unearth at least one safe, high-yield investment every month for Oxford Club members – all of which are capable of generating years and years of income and modest capital appreciation.
In fact, every single recommendation is profitable to date. That includes our special bond fund that also provides inflation protection.
Collectively, these dividend-yielders are generating a safe 7% income stream. Try matching that at your local bank.
Good (and safe) investing,
Louis Basenese
P.S: In the latest issue of The Oxford Club’s Communiqué, I recommended a company that has increased its dividend every year for 25 years. What’s more, it’s ridiculously undervalued at current prices – trading at a 40% discount to its historical average and a 51% discount to the average S&P 500 stock. The stock hasn’t been this cheap in over 20 years. But it won’t last long. To find out why, sign up for your risk-free trial membership to The Oxford Club.
- 6 Steps for High Yield Dividends
- Nucor (NYSE: NUE) & The Golden Dividend Ratio
- The Dividend Stock Recovery: Get Ready for a High-Yield Bonanza
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6 Responses to “Choosing Dividend Stocks: Six Steps For Finding These Safe, High-Yield Investments”
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In addition to being the foremast expert on small-cap stocks, Louis is also well versed in special situations including IPOs, mergers and acquisitions, spinoffs and contrarian investments. His commentary has been featured in several media outlets, including MarketWatch. And he's also a top-rated speaker at financial conferences throughout the country. 
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January 22nd, 2010 at 6:46 pm
Louis,
A quick question about dividend stocks, should you re-invest the dividends or allow dividend to increase cash balance?
Thanks.
Reply
Investment U Reply:
January 26th, 2010 at 1:48 pm
Tom,
That really depends on what your personal situation and what you’re looking to get out of your investing experience. We suggest that you consult a financial advisor about which is best for you.
Good investing,
Investment U
Reply
January 23rd, 2010 at 8:50 pm
Mr. Basenese:
In your January 22 Investment U article you refer to a stock you recommended in the latest issue of the Oxford Club Communique. The January, 2010 issue is the latest on the web page. In that communique you dealt with small-cap stocks, and I cannot find reference to the undervalued company with history of increasing dividends. Are you possibly referring to a recommendation in the forthcoming February communique which has not yet made it to the web page?
Thank you.
Don Barnhorst
Reply
February 7th, 2010 at 5:14 am
Like the article says: beware of very high dividend yields. There are plenty of stocks available that still pay a respectable dividend.
Check out the top 250 here:
http://www.TopYields.nl/Top-250-dividend-yields.php
Reply
February 21st, 2010 at 4:03 am
I believe I am a member of Oxford Club. If so, why continue to send me wasteful teasers?
If I’m not a member, please advise.
Reply
Investment U Reply:
February 22nd, 2010 at 9:24 am
Joe,
We must apologize for these types of “wasteful teasers” that we continually send to our subscribers, but these types of advertisements help to keep Investment U free. If you wish to stop receiving these promotions you can unsubscribe from those adverts or you can follow IU through our RSS feed on your feed-reader.
Thank you,
Investment U
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