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.
7 safe dividend plays
To get you started, here are seven promising dividend plays to consider:
This company is the world's second-biggest cigarette seller, after China National Tobacco. Philip Morris International controls the rights outside the United States to such brands as Marlboro, Virginia Slims and Parliament. So it's positioned to sell more cigarettes as smokers in rapid-growth emerging markets earn more and trade up to premium brands.
Insiders continue to buy the stock, suggesting room for further appreciation. And, of course, tobacco's addictive nature assures steady revenue. If you oppose smoking for moral, health or other reasons, this stock is not for you. As an ex-smoker, I'd understand.
The regional bank has 1,800 branches in the Southeast and Washington, D.C. Even during the worst of the credit meltdown, BB&T was profitable. The company used its financial clout to attract customers from competitors and purchase the assets of a failed bank in Florida from regulators.
As the economy improves and loan business grows, Wordell believes the bank could see annual earnings as high as $3.50 a share, from $1.21 recently. Wordell expects the bank to raise dividends as earnings and loan quality improves.
With a stable of popular brands such as Crest, Tide, Bounty, Duracell and Pampers, this company produces a steady stream of revenue that should support its stock price. No matter how tough times get, people need toothpaste, detergent and diapers.
The company has excellent marketing skills and a global reach. "There are few safer ways to play the pent-up spending of the emerging-market consumer than an investment in P&G," says Morningstar analyst Lauren DeSanto.
4. Johnson & Johnson has a dividend yield of 3.4%.
The world's largest health care company provides investors with exposure (similar to that of a mutual fund) to the health care sector. The company has three main divisions: pharmaceuticals, medical devices and consumer products.
Johnson & Johnson has had its share of quality control issues, but that's no reason to avoid this stock. The company's strong research pipeline, broad product lines and abundant cash flow mean it will continue to grow -- and keep increasing dividends.
Among the company's best-selling drugs are Humira, used to treat autoimmune diseases, and Kaletra, a treatment for HIV and AIDS. The company also sells medical devices, including stents, blood diagnostic kits and nutritional products.
Abbott has a few potential blockbusters in its pipeline, including a treatment for kidney disease. "It's just a good defensive, cash-generating vehicle," says Wright.
Utilities are the classic dividend play from your grandparents' day. They're still a good place to get yield.
Wright says he favors PPL in part because the provider of electricity to customers in Pennsylvania, Kentucky, Virginia and Tennessee is out of favor with investors. "Your risk/reward is not going to get much better than it is now."
Electricity demand should increase as the economy picks up. And much of the revenue from increased sales will fall to the company's bottom line, because PPL generates power from lower-cost energy sources, particularly nuclear and coal.
This utility serves central and Northern California, where regulators are telling utilities to develop renewable sources of energy such as solar and wind power. As PG&E does so, Wordell says, the company will be allowed to raise rates, which will boost earnings, allowing the company to raise dividends.
In sum, the seven recommended dividend-paying stocks are: Philip Morris International, BB&T, Procter & Gamble, Johnson & Johnson, Abbott Laboratories, PPL and PG&E.
What about risks?
Of course, dividend stocks can lose value, and you could eventually lose more than you'll earn from dividends.
But companies like these, with financial strength and a record of paying dividends, should be able to recover from any downturn. "If you are patient, you won't suffer any capital loss," says Wright.
Another risk is that the tax rate on dividends, currently 15%, could be raised when the prevailing capital-gains rate expires at the end of the 2012. I don't know how this will turn out, but there's a chance a political compromise will be reached that prevents dividend income from once again being taxed at the rate for ordinary income.
At the time of publication, Michael Brush did not own or control shares of any company or fund mentioned in this column.
Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.
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