Tuesday, July 13, 2010

Investing for Dividends

Dividend Yield
Some Reasons to Invest In Dividends

One way to profit from owning stocks in a market downturn is to buy and own stocks paying high dividend yields. If you can't be active in the markets, then you can buy and hold dividend stocks paying a high yield. Hopefully a yield that is paying as much or more than inflation. So a yield of 5% plus would be attractive.

Investing is rarely easy, but it's unusually difficult these days. Cash, T-bills and money-market funds offer microscopic yields. Long-term Treasuries pay more, but they're exposed to the threat of higher inflation. Stocks were legitimately cheap a year ago, but stocks are hard to buy in a crisis. As the crisis passed, prices shot up, and bargains quickly vanished. Yet one fact remains crystal clear: Investors cannot count on capital gains alone.

This basic menu for your money may not sound appetizing, but it could be worse. On any given day, we might hear of market-timing strategies, technical analysts and their squiggly charts, gold and other commodities, options, futures, private partnerships and so on. These strategies may have merit if you can make investing a full-time job and you have a glass-lined stomach for the risk, stress, and inevitable losses involved.

What I'd like to do is cut through all this clutter with a simple proposition: Let's make investing simpler, more practical, and more likely to yield good rewards. Collecting healthy cash dividends may not be the only way to make money, but after considering the alternatives, dividends may be the best.

What's the strategy, in a nutshell? Seek to invest in good businesses that pay large dividends that grow over time, for long-term rewards. To do this, think less like a trader, and more like a businessman. Let's take a look at a few key points.

It's Just Good Business

A good business is not simply one whose stock happens to be going up. A good business has characteristics that we would seek if we were looking to buy the entire thing, even if when only looking at a small, publicly traded slice. Such as: 1. Steady cash flow through good times and bad, 2. Sound financial footings with no Wall Street hocus-pocus, 3. Enduring advantages over their rivals, 4. Management that is both competent and committed to treating shareholders like owners and partners, not just anonymous donors.

Pay Me Now and Later

Many large businesses score well on the criteria listed above, but what of my last point? How can we know that CEOs and directors are treating shareholders well? Dividends, of course, meaningful and sustainable payments of cash that reward our investment directly.

Lots of companies pay dividends, but most are far too small. A yield of 1% does nothing for you, even if short-term interest rates are near zero. What you want to see are yields well above the market's average of 2%. Not only do yields of 3%, 5% or 7% demonstrate that a business is run on a paying basis for its shareholders, but they provide income that investors can use to fund their retirement or reinvest to earn even more income down the road.

Not Just Income but Income Growth

Even so, the dividends you receive today are only part of the story. Investment recommendations must also provide increasing dividends over time. Think of it this way: A 5% dividend yield from, say, Consolidated Edison ED looks good at first glance. Yet if that dividend doesn't grow at least as fast as inflation over time and Con Ed's hasn't, the stock isn't going to have much reason to go up. You might as well own a bond. But when you can combine a good dividend yield with reasonable, sustainable growth, you'll have an investment machine firing on all cylinders.

In It for the Long Haul

Finally, with dividend investing you want to take a long-term view. I know this is not a popular perspective these days; most of Wall Street and its media hounds are all about action, action, action. But this isn't how a good entrepreneur invests; enduring rewards take time to build. Dividends in particular have virtually no use for speculators and market timers. They take months and even years to accumulate. But as they accumulate, dividends reduce your risk and build lasting returns.

You might be thinking, "If only investing could be this simple!" But why make investing more complicated than it needs to be?

Simple, of course, does not necessarily mean easy. Like all investors, you've had to deal with a bubble and bust economy, uncomfortable volatility in stock prices, companies that fail to hold up their end of the bargain and, at times, your own mistakes. But the bottom line is this: Through a terrible period for the stock market, this process has enabled investors to generate higher returns than the market in general and a lot higher than dividend paying stocks as a group. The good dividends that accumulate, grow and compound have kept your portfolio on the right track.

Recognize that these are difficult times we live in. It's tough for savers and investors to get a fair shake. The markets are not always kind, even to investors who stick with a sound, long-term, income-rich strategy.

Yet dividends provide a way to put your money hard at work through income and income growth. Better yet, a dedicated approach based as it is entirely on dividend prospects has demonstrated that it can make your dividends work even harder.

My "pitch" holds no mystery: If Dividend investing sounds like a method that might help you meet your family's financial goals, then give it a try.

Click here for more dividend investing information and services from Morningstar Investment Research