Part of constructing a winning portfolio includes finding stocks that pay high dividends - but there are some components to that strategy that investors must learn now to be successful.
At a time when CDs, Treasuries and money market instruments are yielding next to nothing, scores of investors are pouring money into the highest-paying dividend stocks.
But, there's a problem...
Indeed, five years of zero interest rate polices (ZIRP) has created distortions, pushing income-hungry investors to take on some added risks in terms of quality and duration.
Many investors - lured by hefty payouts - fail to look at a stock's fundamentals.
For example, some yields are high because the stock's price has appreciatively fallen. If the slump is temporary, it could portend an appealing opportunity.
If the fall is due to slumping product sales or management problems, the price decline could continue - and the dividend could be on its way to being slashed.
Another source of high-yield portfolio happiness, real estate investment trusts (REITs), can offer yields as high as 15% -- but these substantial payouts may not last.
When Stocks that Pay High Dividends Turn Cold
When, not if because we know it's coming eventually, the Federal Reserve starts to taper its quantitative easing program (created to keep interest rates low and goose the ailing housing market), residential mortgage REITS are likely to slash dividend payouts. Share prices of some will tumble.
You see, since interest rates have hovered near zero for more than half a decade, mortgage REITs have enjoyed borrowing at these historic low rates to buy mortgage backed securities (MBS). The sizable spreads between low rates and the MBS yields have allowed REITs to reap significant profits, which they have passed on to shareholders through hearty dividends.
Since the first mumblings of a Fed taper, REITs and their shareholders have felt the effects. Here are just three examples:
American Capital Agency (Nasdaq: AGNC), down 21.9% year-to-date, trimmed its dividend by 16% on June 18.
American Capital Mortgage Investment Trust (Nasdaq: MTGE) has fallen 15.8% since January, and it slashed its dividend 25% on June 18.
Annaly Capital Management Inc. (NYSE: NLY) off 16.5% since the start of the year, cut its dividend 11% on June 19.
In short, when the Fed makes a move, not all dividend stocks will be good buys.
"High dividend yield doesn't give you a place to hide in an environment that doesn't favor equities," Sharon Hill, head of equity quantitative research and analytics at Delaware Investments, told The Wall Street Journal.
How to Find Stocks that Pay High Dividends - and Are "Buys"
This means investors hunting for dividend stocks need to be selective.
Consider, what you may give up in yield, you'll more than make up in long-term growth - and peace of mind.
And stay nimble. Don't "set it and forget it" forever.
"Dividend strategies need to shift," Russ Koesterich, chief investment strategist at Blackrock, told The Journal. "Otherwise investors may find that instead of changing with the times, the times change them."
Here are five things to keep in mind before settling on certain dividend stocks:
- Look for a company with a long dividend history. One place to start is with the Dividend Aristocrats - stocks that have increased their dividend every year for 25 consecutive years.
- The company's payout ratio should be no more than 80% of its earnings per share. If the company is irresponsibly borrowing money to pay dividends, steer clear. Apple Inc. (Nasdaq: AAPL) had $145 billion on hand at the end of the Q1 2013 when it announced it would borrow money to fund a 15% increase to its quarterly dividend and bigger share buyback ($50 billion to $60 billion). Obviously, the iPhone maker was taking advantage of rock-bottom interest rates and a tax break. "We applaud Apple's decision to borrow money and return excess capital to shareholders, an idea that was off the table only months ago," a Greenlight Capital spokesperson told MSN Money. "This positive development represents a more shareholder friendly capital allocation policy and demonstrates the conviction of Apple's management and board in the Company's future."
- Pick multinational companies as those with a worldwide market presence tend to provide somewhat of a hedge against inflation.
- Choose companies with a stable product line and ones that stick to its core business. People will always need to eat, use toothpaste, heat their homes and fill up their cars with gasoline.
- Look for stock price stability. Solid dividend payers are typically less volatile than the market as a whole, and help soften the blow in falling markets. They also add a kick and cushion to any portfolio. But beware if a stock price has soared so much recently that the P/E ratio is looking pricey. Some of the most popular dividend stocks have become more expensive this year as yield-hungry investors piled in to shares and driven prices higher.
Now that you have an idea of how to find the best stocks that pay high dividends, we've given you three to start with - go here to get your solid dividend investing strategy started - for free!
Related Articles:
- The Wall Street Journal:
Best Dividend Stocks to Own - MSN Money:
Apple borrows to fund dividend, share buyback - Kiplinger:
5 Reasons That Dividends Matter
Credit: Money Morning - Only the News You Can Profit From http://feeds.moneymorning.com/~r/moneymorning/jOLe/~3/dUmp957aoZc/
