Three Tips for Dividend Investors

The market has gotten just a little bit ahead of itself in terms of valuing dividend-paying stocks, says Morningstar's Josh Peters. Here are three tips for dividend investors today.

Three Tips for Dividend Investors Dividend Investing with Josh Peters Morningstar Josh Peters: Hello I’m Josh Peters Editor of Morningstar dividend investor could it be that dividends are becoming too popular? This might not sound like a question that the editor of a dividend investing newsletter would necessarily want to ask allowed but I think it’s very important that investors always keep the most critical factors in mind total return when they’re making investment decision for their portfolio and nothing, nothing is going to affect your total return more than the price that you’ve paid for your stocks. So let’s take a quick look at some numbers. If we look at the performance of stocks in 2010 thus far which really hasn’t been that great of a year we see that dividend paying stocks is measured by the two index as you see on the screen have been out performing. In fact the harvest portfolio which is one of the too model portfolio’s that I manage in dividend investor has actual performed very well in this environment. Part of that I would like to think it has to do with the fact that dividend paying stocks are simply better companies and then investors are starting to realize that after about a 1520 year period of placing primary emphasis on this on capital gains and growth instead of dividends that perhaps a good bird in the hand is worth the two or more in the bush. On the other hand of the spectrum we have to consider what’s happened to interest rates in this environment. Where have they gone, nothing but down. Seeing a tenure treasury bond paying only 2-1/2% and seeing many shorter term money market funds and CDs paying far less even than that is certainly chasing some money into the stock market especially dividend paying stocks that might not otherwise be there. What kind of effect that this have on price and future total return. Well it has made prices go up and as prices go up future total return potential tends to come down. If we look at morning service coverage of domestic stocks find that about a 156 stocks are yielding 4% or more as of September 27 but 55% of these stocks are actually over valued. They’re not massively over valued. We don’t have very many one star stocks in this group but only three actually come in with our 5 star reading under valued enough to have our 5 star rating. Now if we look at the rest of the dividend paying universe. Those stocks that yield more than zero but less than 4%, 58% of these stocks we think are undervalued relative to our fair value estimates which are based on RSS one of the companies intrinsic value. So this is telling us that perhaps the market has gotten just a little bit ahead of itself in terms of valuing dividend paying stocks relative to the stock market as a whole. Now how big of a problem is this. Well if you’re continuing to hold dividend paying stocks as part of a long term investment strategy and you had the opportunity to acquire shares at good prices in here as fast. I don’t think there’s anything to worry about. The type of over evaluation we’re looking at is not the territory where you typically would want to run for the hills. At the same time investing at new money at this point in a dividend strategy I think has become a little bit tougher when prices are not that favorable relative to the intrinsic value of the business, relative to the package of dividend growth and current yield that will drive your total return in the future you don’t have a lot of room for error. You don’t have the margin of safety that Ben Gram preached all those years ago so what might you consider? Well first make sure you don’t confuse your safe money with your stock market money. No matter how attractive the dividend yields might be on some stocks even those that have come up from their rolls you don’t want to assume that you can get your money back exactly what you put into a stock over the next couple of years if interest rates go up a lot of these stocks could be worth less. Even if their dividends are maintained or even continue to grow. Second in equally as important, you might want to consider rolling money into stock slowly, dollar cost averaging over a series of months maybe even a couple of years. I don’t thin it’s necessary to take all of the money that you might eventually want to have invested in dividend stocks and move it in at a single price point in the market. Give yourself the opportunity to benefit from this variations and prices as time unfolds. Finally if you’re the kind of investor who isn’t all that concerned about needing a big margin or safety even though I do think it is a good idea and you would be willing to pay the kinds of prices in exchange for the dividend yields and total returns that we see from this point going forward I would say probably 8 to 10% for the universe of higher yield and stocks in the U.S and do yourself a big favor probably the best favor you can do for yourself at just about any point in the market sticks to the highest quality name. I found in the years that I have been managing dividend investor that when I relaxed my standards in pursuit of a bit more yield, a bit more growth or just a cheaper stock I can wind up getting burned that’s why I like to stick with the best quality names even if I have to pay a little bit more for them. Three names that I think are very, very attractive businesses even if not quite so attractive in terms of their current evaluations are Philip Morris International which owns the Marlboro brand all around the world other than in the United States recently raised its dividend more than 10% kind of unusual for a stock that has already been yielding a high 4s even low 5s. Amerigas partners which is the nation’s largest distributor of propane are very good business s doesn’t grow a whole lot but the companies tend to have very good pricing power. Sticky customer relationships and it’s a wonderful cash cow business in this case with a 6.3% yield and waste management. One of the unsung heroes as far as I’m concerned from the industrial sector that has this played a tremendous amount of cash to shareholders direct benefit through dividends and share rate purchases and hasn’t gotten a whole lot of credit for it. It’s also very good business owning a land fills practically a monopoly. You know tends to lead to pretty high returns on invested capital. All three of these businesses have attributes that I like as business is I don’t like their stock prices quite so much. I would rather buy them cheaply especially in case I happen to be making a mistake with regard to my expectations, but these are the first names that you want to consider I think in a market down turn and if you are willing to pay that extra dollar or two in order to get invested more quickly these would be some names that I would find relatively attractive. So making investment decisions in this environment isn’t always easy. Stocks aren’t necessarily cheap especially the kinds that pay high dividends that so many people are finding attractive these days but I think it’s a good opportunity to take the long term perspective and to think like a business owner. Think about what you’re really getting in return for your capital and perhaps for the little patience and time on your side as you look to migrate your portfolio toward more income over time. With that I would like to thank you very much for watching this has been Josh Peters Editor of Morningstar Dividend Investor.