How to Think About Dividend Investing In a Bull Market

Thursday, 19 Apr 2012 07:05 AM

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What makes a dividend stock tick? A high payout, or consistency?

If you picked consistency, congratulations. You are likely to make yourself quite rich using a dividend strategy.

Yet, with interest rates at rock bottom, investors seeking yield have been pushed into alternatives, including master-limited partnerships, real estate investment trusts (REITs) and dividend stocks.

Editor's Note: Google Banned This Video But You Can Watch it Here

As Jason Zweig notes in The Wall Street Journal, to date $9 billion has moved into stocks and funds that pay stable, high or rising dividends. Meanwhile, all other stock funds have a lost a comparable amount, down $7.3 billion.

Bully for the blue chips, but as Zweig points out, the risk is rising that investors are chasing returns. “Think twice before you jump on the bandwagon. While dividend-oriented funds are a perfectly legitimate way to invest in stocks, you shouldn't mistake them for bonds,” he concludes.

The reason is simple enough. Investors seem to be ignoring a plain fact: Stocks can go down.

Bond funds also can slide, and the bond market represents no less a risk if inflation outpaces yields, but the two assets have important differences.

Held to maturity, a highly rated bond will return your capital.

No matter how blue your blue chip, it can go bankrupt. Dividends can be cut. You might lose everything.

So what can you do about that? Given the bond market’s continuing, powerful rally, one might conclude that the reasonable course is to suck it up and buy bonds. But there is a way to balance your relative risk, by closely considering your dividend stock selections.

Here are two important questions to yourself when looking at potential dividend picks:

Question No. 1: Is the company able to pay its dividend consistently?

One way to check this is to look at the Standard & Poor’s Dividend Aristocrats list. All of those stocks have increased their dividend payouts for at least 25 consecutive years. They might not pay a dividend that will knock your socks off, but these are the companies that clearly have dividend consistency as corporate policy.

The current list has 51 stocks on it with an adjusted market cap of more than $1 trillion. Some of the top stocks by market cap include Coca-Cola (KO), McCormick & Co. (MKC), Lowe’s (LOW), and Family Dollar Stores (FDO).

Question No. 2: Would I buy more if the price fell?

This is crucial. If you are investing for appreciation alone, you are perhaps missing the point of dividend investing.

It’s important to get into a dividend stock at the right price, in order to get what Warren Buffett calls a “margin of safety” to protect yourself from capital loss.

But declines will happen, even from supposed lows. If you think it through, a lower price means you a chance to average down your basis on the position, using cash or incoming dividends to buy more.

If your reaction to that idea is “no way!” then you probably bought the wrong dividend stock and should reconsider your strategy, or at least rethink the position.

Editor's Note: Google Banned This Video But You Can Watch it Here



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