Sophisticated investors know that even a little dividend income makes the difference between a miserable year in the market and a relatively easy recovery.
After all, stocks swing up and down with sentiment. However, when companies hand you a piece of the profit every three months, Wall Street’s shifting moods will never take it away. Even getting 2 percent of your investment back in a typical year makes the difference between losing money and breaking even 10 percent of the time.
Investors who capture that yield can wait longer for a stock market crash to play out before they need to liquidate. And if you need the income, the checks help pay the bills.
Unfortunately, the S&P 500 barely pays 1.9 percent a year. Even when the market was at its weakest, investors only got a chance to lock in a 2.2 percent yield.
That’s a problem because, as I said on Fox Business News yesterday, “patience” at the Federal Reserve gives inflation free reign to take a bigger bite out of your real investment returns.
When the market is rallying, that’s not a problem. But since 2 percent happens to be the floor of the Fed’s inflation comfort zone, you need to earn at least that much in the lean years to preserve your buying power.
And because the Fed has proved it can get a little behind the curve, that’s why I start my Value Authority yield screening process at 3 percent.
Not every stock on the list will make that grade, especially if the growth profile is robust enough to make me think we can beat the market via pure price appreciation. But it’s a good place to start.
Start With a Reliable Base
The secret of yield investing is locking in the best number you can. That means filling a shopping list with companies that pay what you need under the right conditions and then waiting for the market to give the money to you.
You might need to wait months or even years before some names become available at a price that translates into a reasonable yield.
Apple Inc. (NASDAQ:AAPL), for example, would need to drop below $88 for the current dividend to add up to 3% of the stock price. That’s unlikely to happen any time soon.
But JPMorgan Chase & Co. (NYSE:JPM) will pay 3 percent while you’re waiting. Smaller banks like Valley National Bancorp (NYSE:VLY) provide an income base above 4 percent and are a key component of my income strategy.
Utilities, on the other hand, rarely provide a reasonable trade-off between their yield and upside. The businesses simply aren’t growing fast enough to get Wall Street interested.
Even my favorite utilities like American Electric Power Co. Inc. (NYSE:AEP) are only growing 4 percent a year to back up their 3 percent yields.
In these cases, the dividend becomes a ceiling on your return as well as a floor and these stocks start to behave like higher-paying bonds. There’s a role in every portfolio for that.
While I could list the names of companies that are in the 3 percent zone forever, the list is always in flux. Tomorrow, a stock you love might rally so hard the yield isn’t worthwhile. Or a Kellogg Co. (NYSE:K) can drop to the point where you back up the truck to lock in 4 percent a year yield.
Either way, your goal is to keep rotating up the yield curve. When you see a stock that pays more than what you’re getting, free up room in the portfolio and grab a little more income for life.
Capital appreciation is incidental. You don’t want to sell except to lock in something better.
Exceptions and Aberrations
Some companies will entice you with a little yield and a lot of appreciation potential. Avocado producer Calavo Growers Inc. (NASDAQ:CVGW) is an obvious example of how this works.
CVGW only pays a 1.2 percent yield right now. Even on the dips, that yield rises to 1.4 percent. That’s not going to stay ahead of inflation on its own. But with earnings on track to expand 60 percent this year, there’s room for the stock to surge, management to increase the dividend or both.
Of course, a stock like that always can drop and leave you with a temporary paper loss. It happens. The yield is there to cushion the blow and give you more time to be patient.
And the opposite scenario happens all the time, with huge notional yields beckoning investors even though the payout is too good to be true.
AT&T Inc. (NYSE:T) is a good case in point. Sure, it shows up as a 6.5 percent yield today, but the company simply isn’t growing fast enough to move the stock in the long-term.
Can you find stocks that might pay more than 6.5 percent a year? Probably. I do it all the time. Allocate a bit of your capital to let Big Telecom help pay your monthly bills and move on.
But be selective. While CenturyLink Inc. (NYSE:CTL) looks a lot like a smaller AT&T, what was once a 12 percent yield has proven to be illusory in the long haul.
Management has just conceded that paying $2.16 a year per share when you’re only earning $1.20 in profit wasn’t a sustainable proposition. The company’s directors cut the dividend in half and made a lot of people unhappy.
We saw it coming and steered clear. As a rule of thumb, if the cash isn’t there, you’re not locking in anything.
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