Home [ Market Workshop ] [ Stock Analysis Checklist ] [ Market Glossary ] [ Basic Training ] [ Best Investing Sites ] [ Death List ] [ Free Tutorials ]

High dividends

REITs and other dividend paying stocks are getting more attention, and for good reason. You get paid just for holding a stock, instead of hoping to make a profit when you sell. High dividend stocks are less volatile than the overall market. The high dividend supports the share price since a price drop increases the dividend yield, making the stock more attractive. 

Dividend Yield
By way of definition, your dividend yield is the total dividends you receive over a year divided by the price you paid for the stock. For example, your yield is 10 percent if you pay $10 per share for a stock that pays dividends of $1 per share over the next 12 months ($1/$10). 

Only around 2,300 of the 6,500 or so stocks listed on the three major U.S. exchanges paid a dividend for their last reported quarter. Of those, about half paid dividends reflecting yields of three percent or less, roughly what you’d expect from money market funds or CDs. 

Since dividend-paying stocks are riskier, you’d expect to be compensated by higher returns. Assume for the sake of discussion that a six percent average annual return from dividends works for you.

Screen for Dividends
As of last week, 658 stocks were yielding six percent or higher based on their recent share prices and most recent dividend. That’s too many to analyze, so I devised a screen to narrow that list down to the most promising, and came up with 83 candidates. I’ll give you the details of the screen in a minute, but first a rundown on the results.

Most of the stocks turned up were real estate investment trusts (REITs), which by law, must pay out 90 percent of their income to shareholders in the form of dividends. REITs generally specialize in a specific sector such as apartment complexes, office buildings, shopping centers, etc. Most of the REITs turned up in my screen were yielding from 7 percent to the low 9 percent range. Mortgage REITs, firms that finance real estate based on underlying property values, were yielding more, in some cases, above 16 percent. 

In my experience, yields much above 10 percent signal risk. In the case of mortgage REITs, they borrow short-term money and invest it at higher long-term rates. The spread between short- and long-term rates determines their profit margins. Some experts expect the currently high spread to narrow when the economy recovers, pressuring future profit margins.

Natural gas and petroleum product pipeline operators comprised the largest category turned up in my screen. Financial solvency issues concerning Williams Companies and El Paso Corporation have pressured all stocks in the category. While they do operate pipelines, it was energy-trading shenanigans that triggered Williams and El Paso’s problems. Most pipeline operators are not involved in energy trading and are financially strong. Pipeline operators are typically organized as master limited partnerships. MLPs are similar to REITs and are required to distribute most of their earnings in the form of dividends. However, MLPs have different income tax advantages and disadvantages, and you should consult your tax advisor before investing.

Eastman Kodak, Fleet Boston Financial, and a smattering of other banks, finance companies, manufacturers, oil tanker operators, and utilities also turned up in my screen.

I don’t have room to cover everything, but here are some factors to consider when analyzing high dividend payers.

Dividend Safety Crucial
The dividend payout safety should be your prime consideration. Ideally you want to see the dividend increase, but at a minimum, you don’t want to see it decrease while you hold the stock.

You can gain insight about future prospects by reviewing the firm’s dividend history on Morningstar. (www.morningstar.com). Get a quote and then select the Stock Performance report (left menu) to see the dividends paid going back to 1997. Look for a pattern of steadily increasing dividends. Avoid companies with fluctuating or erratic payout histories.

I’ll explain additional considerations as I describe the screen I used to narrow down the candidate’s list. I used Multex Investor’s NetScreen, but you could run a similar screen using MSN Money’s Deluxe Screener (moneycentral.msn.com/investor).

Note: the Multex NetScreen program is no longer available. Use MSN Money's Deluxe Screener.

Screen for High Dividend Stocks 
Start by selecting Screening Tools from Multex Investor’s homepage (www.multexinvestor.com). NetScreen looks intimidating, but Multex provides an excellent tutorial. Here’s a rundown on the screening criteria I used, including each parameter’s NetScreen category and name in parenthesis after the test description.

• Safety is important, so it makes sense to limit your selection to stocks traded on the major exchanges. I specified that all stocks must be listed on the New York, American, or the Nasdaq exchanges (Descriptive/Exchange).

• Low share prices signal problems. Therefore I screened out candidates trading below $4 per share. Try increasing the minimum to $10 if you get too many candidates (Price & Volume/Price).

• Low stock trading volumes reflect lack of interest and susceptibility to price manipulation. For that reason, I required a 50,000 (0.05 million) minimum average daily trading volume (Price & Volume/3-Month Average Volume).

• Since earnings growth propels dividend growth, I required that analysts must be forecasting at least four percent average annual long-term earnings growth to weed out firms with shrinking earnings. Yes, I know about the problems with analysts, but their consensus growth forecasts work for this purpose (Earnings Estimates/Mean Long-term Growth Rate).

• I called for a minimum three percent average annual dividend growth rate over the past three years to screen out stocks with flat or declining dividends. Try increasing the minimum if you get too many candidates (Growth Rates/Dividend Growth Rate).

• I specified a minimum six percent dividend yield. You can vary this requirement based on your needs (Dividend Information/Yield). 

Your candidate’s industry outlook is an important consideration. Most industry players prosper or suffer together depending on the economic cycle. You’ll find a variety of views on the topic by scanning news stories for each candidate on MarketWatch (www.marketwatch.com).

Successful high-dividend investing hinges on avoiding problem firms or industries. Don’t skimp on your research.
Published 8/11/02