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High Yield
Stocks: the
15 Percent Strategy
Capital appreciation + high
dividend yield = 15% return
Would you be satisfied with a 15 percent average annual return while you
wait for those bygone dot-com days to
return?
Dividends
Can Help
If you do the math, you’ll find that 15 percent doubles your money in
five years. Achieving 15 percent may or may not be doable based solely
on stock appreciation, depending on your stock picking skills. It’s a
great deal easier if you split the chore between stock dividends and
price appreciation. You would only need to realize nine percent stock
appreciation if you’re also pocketing six percent in dividends each
year.
High dividend
yield stocks are less risky than growth stocks, as long as the company
keeps pumping out the dividend, because investors are content sit back
and collect their checks when the market gets rough.
High
Dividends
The strategy involves finding
stocks paying dividends yielding at least six percent annually, and
likely to increase their dividend payouts ten percent, or so, each year.
Hopefully, over time, the stock price will follow.
Dividend
Yield
Let’s define dividend yield before we get into the details. Your
dividend yield the next year’s dividends divided by the share price
you paid. Your dividend yield is ten percent if you paid $10 per share
for a stock that paid out $1.00 per share over the next 12 months
(dividends are usually paid four times a year). Your yield would only be
9.1 percent if you waited a week to buy, and you paid $11 per share
instead of $10.
Finding
High Dividend Stocks
Business Week Magazine’s “BusinessWeek online” site (www.businessweek.com)
features a screening program that works well for finding dividend paying
candidates.
Note: as of 1/17/07,
Business Week's screeners were no longer available. You can run a similar
screen using MSN Money's Deluxe Screener (moneycentral.msn.com).
MSN's screener requires downloading special software it's free.
Get there by
selecting “Tools
& Scoreboards” from the menu on the left, then click on “Stock
Search,” and finally select “Advanced
Stock Search.” Business Week’s advanced screener provides 71
search parameters, but we’ll only need five:
-
Analysts Buy Hold Sell Mean
(average)
-
Cash Flow Growth One-Year
-
Dividend Yield
-
Projected EPS (percentage
growth) Current Fiscal Year
- Sale Growth (percentage),
One-Year
You can
specify a minimum value, a maximum value, or both for each screening
parameter.
Analysts
Ratings
Minimizing the risk of a company
reducing its dividends while you own the stock is the most important
element of this strategy. One step in the process is to avoid stocks
that analysts are recommending selling. Companies such as Zack’s
Research average the analysts’ buy, hold, or sell recommendations for
each stock into a single number called the analysts’ consensus rating,
With this system, 1.0 means “strong buy,” 2.0 means “weak buy,”
and 3.0 to 5.0 equate to gradations of “sell.” Specify a range of
1.0 to 2.5 for “Analyst Buy Hold Sell Mean” to eliminate stocks with
“sell” ratings.
Cash Flow
Growth
Cash flow is the money that flows
into, or out of a company’s bank account resulting from its basic
operations. Cash flow is different than earnings, because a myriad of
arbitrary accounting decisions affect the reported earnings. Dividends
are paid out of a company’s cash flow, and cash flow growth can lead
to growing dividend payouts. Specify a minimum one-year cash flow growth
of 10 percent to stack the odds in your favor.
Dividend Yield
The premise of the strategy is to find stocks paying at least a six
percent dividend yield, and you would think that higher is better. But
I’ve found that abnormally high dividend yields lead you to problem
stocks. Specify a minimum dividend yield of six percent, and a maximum
of 12 percent, but be especially careful when evaluating stocks with
yields over nine percent or so.
Earnings
Growth
While dividends come from cash
flow, flat or declining earnings signal problems that could jeopardize
the dividend payouts. Require a minimum six percent projected current
fiscal year EPS (percentage) growth to avoid turning up stocks in that
category.
Sales Growth
Increasing sales lead to cash flow growth, and hence to higher
dividends. Specify at least 10 percent minimum one-year sales growth to
weed out the slow growers.
Select 100 from the “Number
of Stocks” dropdown menu near the bottom before you run the screen.
The search turned up 25 prospects when I ran it last week. Consider the
results a list of candidates worth researching, not a “buy” list.
Mostly REITs and MLPs
The majority of stocks in your list will be real estate investment
trusts (REITs), companies that typically invest in a specific real
estate sector, and by law, must pay out most of their earnings in
dividends. We don’t know if the economy is headed for recession, but
if it is, some real estate sectors will suffer. For instance, consider
the stories you’ve heard recently about declining apartment rental
prices.
You’ll also
find Master Limited Partnerships (MLPs) on the list. MLPs are similar to
REITs in that they are required to distribute most of their earnings as
dividends. Many are natural gas pipeline companies that generate
reliable cash flows because their revenues reflect the volume of gas
transported, not the price of natural gas. MLPs offer a tax advantage
over other dividend payers because a portion of their payouts can be
tax-deferred (Consult your tax advisor for details).
Check Financial Health
Use Morningstar (www.morningstar.com)
for the next step in your evaluation. Select Snapshot after you’ve
used the stock’s ticker symbol on Morningstar’s homepage to display
the stock’s price chart. The Snapshot
page displays a substantial amount of fundamental data, including
dividends and dividend yields.
Especially
helpful is Morningstar’s plain-English description of the company’s
business. Just above the description is a section labeled “Morningstar
Stock Grades.” Morningstar gives stocks letter grades ranging from
“A” to “F” in four categories: growth, profitability, financial
health, and valuation. Financial health is a critical factor to make
this strategy work. Avoid companies with less than a “B” grade in
this category.
Do More
You’ll need to do more analysis before you buy, especially to
determine the susceptibility of each candidate’s market sector to a
weakening economy. Plan on holding passing stocks at least two years to
ride out the inevitable short-term problems.
published 4/16/01
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