7/12/2011 4:48 PM ET|
7 dividend plays to consider now
In a struggling market, stocks that provide regular payouts are emerging as a key to investing success -- and a peaceful night's sleep.
Be honest. Did that May-June selloff scare you?
I'm betting it did, because investor sentiment readings took a dive as the minimeltdown played out. Most likely, you caught the fear from the crowd.
But, hopefully, you didn't make the beginner's mistake of selling stocks in a panic, only to see them recover without you. If you did -- or if that queasy feeling during pullbacks just plain makes you mad or causes you to lose sleep -- here's a tip to help you avoid all of that the next time around.
I know, you're thinking dividends are boring -- something your grandparents talk about. But they're right about dividends, which are key to winning in the market.
Below, I offer seven great cash machines you can add to your portfolio now, including such classic dividend plays as Johnson & Johnson (JNJ, news) and Procter & Gamble (PG, news). Before we get there, though, let's understand how dividends help you win.
Here's why dividend stocks aren't boring: From January 1926 through June 2011, the Standard & Poor's 500 Index ($INX) returned 9.97% a year, on average, and reinvested dividends accounted for 41.7% of that return, according to Standard & Poor's.
"Dividends are an important source of total return," says Don Wordell, who manages the RidgeWorth Mid-Cap Value Equity Fund (SMVFX), which invests only in companies that pay dividends, and outperforms the market to boot.
Dividend-paying stocks are safer
There's usually less volatility in shares of companies that pay dividends. That typically means smaller swings during market selloffs, making it less likely you'll get spooked and sell at the wrong time.
Companies paying dividends tend to be in stable, mature businesses. They're not the high-growth companies that invest every penny they take in to sustain growth. But more of those companies will flame out or make mistakes that hurt you as an investor.
Dividends instill discipline
Once a company begins to share its profit via dividends, it's tough for managers to lower the payout. They know investors punish companies for cutting dividends. So paying them makes managers more disciplined. Put another way, dividends are a very public statement of confidence by management.
"It's just a signal about how a company feels about the health of its business plan," says Wordell.
You get paid to wait
No stock rises forever. But dividends pump money into your account even when markets are falling. You get paid to wait out the rough patches.
And unlike bonds, dividends can offer an inflation hedge. At times of high inflation, companies raise prices, meaning they'll have sufficient revenue to keep raising dividends.
If you buy a 10-year bond, your yield remains constant for a decade, even if inflation takes off.
A few tips to bear in mind
Don't make the beginner's mistake of chasing the highest dividend yield. High yields, say 8% or more, can signal issues with a company that investors are taking seriously. Dividend yields (the amount of the quarterly payout divided by the stock price) go up as a company's market value goes down.
To play it safe, go with dividend companies that are financially strong. Here are three key financial yardsticks to consider.
First, look at the company's current ratio, or the amount of cash and cashlike securities on its balance sheet compared with its short-term liabilities, or obligations due in less than a year.
Look for a current ratio of 1.5 or more, says Kelley Wright, the author of "Dividends Still Don't Lie: The Truth About Investing in Blue Chip Stocks and Winning in the Stock Market."
To find a company's current ratio, go to its quote page on MSN Money (for example, Johnson & Johnson's quote page is here). Click on the tab labeled "fundamentals;" find the "key ratios" heading; go to "financial condition." You'll see that Johnson & Johnson has a current ratio of 2.0.
Next, look at the payout ratio. This is the percentage of earnings paid out in dividends. Wright wants a payout ratio that is no more than 50% of trailing 12-month earnings.
Here's how to find the payout ratio at a company's quote page on MSN Money: Click on the "fundamentals" tab; find "financial highlights." Clicking on this headline takes you to a page that reveals the payout ratio. For Johnson & Johnson, it's 48%.
Third, look for the company's debt rating. You'll want to know whether a company has an "investment grade" rating on its debt (BBB or higher) from Standard & Poor's. You can check debt ratings by registering at the Standard & Poor's website and going to the section on corporate bonds.
VIDEO ON MSN MONEY
IF YOU BUY A 10 YEAR REMAINING CORPORATE BOND PAYING 6% AND WE KNOW TREASURIES WILL STAY LOW FOR TWO YEARS UNLESS WE HAVE INFLATION CARTER STYLE YOU WILL BE A BIG WINNER. YOU NEED TO ASSUME YOU WILL KEEP TO MATURITY OTHERWISE THE BOND TRADERS WILL PICK YOU CLEAN.
REITS IN THE MEDICAL FIELDS PAY NEAR 7%
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