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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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