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High
Dividend Stocks Counter Tough Market.
The recent market downturn has creating buying
opportunities for astute investors, especially for dividend stock buyers.
Here’s why.
The dividend yield for a stock is the return
you would achieve over the next 12-months, assuming that both the dividend
payout and the share price remain constant for the year.
It’s calculated by dividing the expected next
12-months dividends by the share price. For example the yield would be 5% for a stock currently trading at $100 per share that is expected to
pay $5 in dividends over the next year ($5 divided by $100). So, the
dividend yield to new buyers goes up when share prices drop.
Thanks to the weak market, yields on dividend
payers with strong fundamental outlooks are higher than they’ve been for
some time.
The best dividend stocks are those that
increase their dividends while you hold them. You win two ways when that
happens. The higher payouts increase your yield and the dividend increase
usually drives the share price higher. Conversely, a dividend drop is bad
news.
Screening is the best way to find dividend
stocks. Screening involves using special programs available on financial
websites to search the entire market for stocks meeting your selection
criteria.
The selection of available free screening
programs has steadily declined over the past couple of years and MSN Money’s
Deluxe Screener (moneycentral.msn.com)
is the only remaining free screener capable of implementing the needed
search requirements.
If you haven’t used the MSN screener, it will
probably take you a couple of hours to figure it out. But once you get the
hang of it, using it is easy (disclosure: I also write investing columns for
MSN Money).
To help you get started, I’ll included in
parenthesis, the instruction phrase needed to implement each search
requirement. I’ll start with dividend yield (Even better,
here's a
link to the complete screen).
High-Yield
he yield must be high enough to make the stock worth buying. What’s ‘high
enough’ is subjective. But, I’ve found that 5% yields usually get the
attention of dividend investors (current dividend yield >= 5.0).
Bigger is Better
Reducing risk is an important part of dividend investing. Bigger
companies are usually less volatile, and, hence, safer, than smaller firms.
Market capitalization, which is how much you’d have to pay to buy all of a
company’s shares, measures company size. Stocks with market-caps below $1
billion are considered “small-caps” and are the riskiest. So, I set my
minimum market-cap at $1 billion (market capitalization >= 1,000,000,000) to
exclude small-caps.
Analysts’ Advice
Stock analysts issue various gradations of buy/sell ratings on the
stocks that they cover. Despite their less than stellar reputations, it
still makes sense to let them do the work, in terms of figuring out a firm’s
fundamental outlook. MSN compiles the individual ratings for each stock into
five categories: strong buy, moderate buy, hold, moderate sell, and strong
sell. For reasons too involved to describe here, “hold” ratings often equate
to “sell.” Thus, I require consensus ratings of ‘moderate buy’ or better
(mean recommendation >= moderate buy).
Earnings Growth
Since earnings power dividends, earnings growth is necessary for dividend
growth. Again relying on analysts, I require long-term (next five-years)
earnings growth forecasts of at least 5% per year, on average.
While that doesn’t sound like much if you’re used to investing in growth
stocks, most high-dividend payers don’t grow earnings faster than 10%
annually (EPS growth next 5-years => 5).
Earn a Dollar
Most dividend payers generate earnings amounting to several dollars per
share annually. In a healthy market, I wouldn’t be so picky, but considering
current conditions, to reduce risk, I require that analysts must be
forecasting at least $1 per share of earnings in the current fiscal year
(Current Yr. Earnings Est >=1).
Track Record
Many high-dividend stocks have only recently gone public and haven’t been in
business long enough to establish a reliable track record. To rule out these
risky bets, I require that passing stocks have been reasonably profitable
for at least the past five–years. Return on equity (net income divided by
book value) is a widely followed profitability measure. For growth stocks,
many experts require at least 15% ROE. But for dividend payers, 10% is good enough (ROE: 5-Year Avg. >=10).
Decent Chart
In a normal market, I prefer stocks with strong price charts, meaning that
they’ve moved up in price in recent weeks. But, in this market, few dividend
stocks would meet that requirement. So, under the circumstances, I’m only
requiring that the share price hasn’t dropped more than 20% over the
past three months (% Price Change Last Qtr. >= -20). Since I arbitrarily
picked that value, modifying it to fit current conditions when you run the
screen.
My screen turned up nine high-dividend
candidates. However, to reduce the odds of picking a problem stock, I used
Yahoo (finance.yahoo.com) to manually check their
dividend histories (get a
price quote, select historical prices and then ‘dividends only’). I’ve had
the best results with stocks that have recorded a consistent pattern of
dividend growth.
One stock flunked that check leaving me with
eight final candidates: Allied Irish Banks (5.0% yield), Bank of America
(5.4%), BT Group (6.2%), Cedar Fair, L.P. (6.6%), Energy Transfer Partners,
L.P. (5.5%), Plains All American Pipeline, L.P. (5.3%), Suburban Propane
Properties, L.P. (5.8%), and TC Pipelines, L.P. (6.5%).
Five of the firms, designated by “L.P.,” are
organized as Master Limited Partnerships (MLPs). They require special forms
at tax time and may not be suitable for tax-sheltered accounts. So consult
your tax advisor before you buy them (disclosure: I own shares of Energy
Transfer Partners).
As is the case for any screen,
consider the results a list of candidates for further research, not a buy
list. Pay most attention to each firm’s business outlook and avoid any
stocks likely to be touched by the subprime mortgage debacle. Also, since we
can’t don’t know when the market will recover, only invest funds that you
won’t need for at least one-year.
published 8/5/07 |
