Value Investing News

This is the first installment in a multi-part series that looks at various options used by income investors to boost their yield while waiting for dividend growth to lift their portfolio’s overall yield-on-cost. This week we are looking at Utilities – those investments long considered as a safe harbor for “orphans and widows.”

I am a firm believer that asset allocation plays a significant part in a portfolio’s long-term results. Recently, I received a question asking if you could have a diversified portfolio of dividend stocks. It is an interesting question that deserves further examination.

Over the last couple of years we have seen companies fail to raise their dividend, cut their dividend and some even decided to stop paying their dividend. In some cases their financials did not warrant the change. So, how do you fin companies with a positive dividend culture?

The dividend aristocrats list includes companies which have increased dividends for over 25 years in a row. It is equally weighted and re-balanced once an year. Over the past 3,5 and 7 years the index of elite dividend stocks has managed to outperform the S&P 500 by 5%, 3.7% and 4.40% respectively.

Back in late 2008 I was invited to participate in a stock picking competition, where the goal was to pick the best stocks for 2009. The picks that I selected were Kinder Morgan (O), Realty Income (O), Con Edison (ED) and Philip Morris International (PM).

Most novice dividend investors typically are under the impression that successful dividend investing entails finding and purchasing the highest yielding stocks. This strategy is flawed, because it does not take into account the sustainability of the dividend. A company, which yields 20%, might generate a much lower yield on cost over time.

Most companies use debt for a variety of reasons in their operations. It could be either short term or long-term obligations. If there’s anything the 2007-2009 financial crisis has taught us, it is that excessively leveraged companies could easily blow up after a chain of negative events. Thus it pays to know what the debt situation for a particular company you are investing in actually is.

When people learn that I am an income investor, the reaction is often a desire to discuss high-yield investments. The uninitiated commonly confuse income investing with high-yield investing. The two are not the same.

Back at the end of 2008, I was invited to participate in a stock picking competition by selecting 4 stocks. At the time I simply included the highest yielding stocks in my portfolio – Con Edison (ED), Realty Income (O), Phillip Morris International (PM) and Kinder Morgan (KMP).

Electric, Gas and Water utilities have always been traditionally regarded as income stocks by investors. Their high current yields, and the relative stability of their distributions made them a preferred choice for investors who are seeking current income from their assets.

What makes investing in dividend stocks so intriguing is the power of compound dividends. Compound interest is what occurs when interest earned is added to the principle and is considered when calculating future interest–i.e. earning interest on interest. Compound dividends are like compound interest, but much better.

As an investor in the accumulation stage, I tend to focus on companies with yields of at least 3% and expectations of future dividend growth. Most of these companies have a history of consistent annual dividend increases which exceeds ten years.

Despite Avery Dennison's recent dividend cut,the dividend aristocrats index appears to be business as usual in 2009.The dividend aristocrats represent S&P 500 members which have consistently raised their dividends for more than 25 consecutive years. At the end of 2008, there were 52 constituents in the index.

Avery Dennison (AVY) just declared a quarterly dividend of 0.20/share, which represents a 50% decrease from last quarter’s payment of 0.41/share. The company reduced its dividend to support debt reduction efforts. The company also reported $0.56 in 2Q earnings per share, which didn’t provide sufficient coverage for the dividend.

Dividend stocks. When you hear those two words what do you think of? Many people think of widows and orphans, along with their stereotypical investment in utility stocks. While others may think of maximizing income by finding the highest yielding stocks available like Real Estate Investment Trusts.