Stocks With High Dividends

| March 28, 2008 | 0 Comments

When my grandfather started saving for retirement he didn’t have much in the way of choices.  Most of his money went into bonds where he collected an interest payment every quarter.  Slowly his portfolio grew to include stocks and mutual funds.  Back then investing wasn’t as complicated.  Investors had fewer choices and transaction costs were high.

At that time the key investment metric was yield.  How much interest did I get from my bond?  What dividend yield did I get from my stock?  It was a quick and easy way to compare various investment options.

But that all changed.

The last bull market started in the mid 1990s.  Over the next few years more than 80% of an investor’s return was generated from rising earnings multiples.  Investors were willing to pay more and more for the same dollar of earnings.  Prices went up dramatically . . . and dividends . . . well they got left behind.  (But more on that in a minute.)

A quick and easy way to see this change is by comparing P/E ratios over different time periods.  A P/E ratio is a simple formula for measuring the value of a stock relative to its earnings.  The “P” part is stock price.  The “E” part is earnings.  Divide price by earnings and you get a decent ratio showing value.  For example, a P/E of 15 means a company’s stock price is trading at 15 times its earnings per share.

The market’s historical P/E ratio is around the 17x or 18x level.  In the late 1990s and early 2000s it got severely out of whack.  In fact, P/E ratios reached levels in excess of 40x in 2001 and 2002!  And that was after the market peaked.  These P/E’s however later proved to be an anomaly.

Look at today’s P/E ratio and you see more normal levels – a respectable 19.5x.  The last 6 years have seen earnings growing much more quickly than stock prices.  This brought P/E ratios back down.

Why is this important?

With corporate earnings growing over the last few years they are generating large amounts of cash.  That cash has to be put to use and one of those uses is dividends.  Over the last few years, dividend yields have been rising steadily.  Investors like dividends.  They give validity to corporate earnings (you can’t fake a dividend); and the tax cut on dividends doesn’t hurt either.

The long term view.

Dividends are important for another reason.  Take a really long look at the market.  Say more than 100 years.  You will notice something very interesting.  More than 65% of market returns came from dividends.

But it gets better.

From 1950 to 2000 dividends accounted for a whopping 72% of market returns.  That’s right.  Most of the gains made long term in the market have come from dividends.  Cold hard cash being sent to investors was key. That’s why the dividend yield is so important, and I only see it gaining in popularity.

I did a quick screen of stocks in the S&P 500.  I looked for the highest yielding dividend stocks and compared their P/E ratios.  Now, before we go any further, a quick word of warning.  Judging a company by its dividend alone is dangerous.  A high dividend may signal more than a great value . . . it could signal huge problems.

If you want proof look at Thornburg Mortgage (TMA).  Just a few weeks ago they had a dividend yield of over 100%.  You could buy the stock and theoretically get more than your purchase price back in dividends.  Of course a few days later they suspended the dividend . . . but it was a nice thought.

So back to the S&P 500.

In my quick screen, I found 63 companies with dividend yields in excess of 4%.  More than half a dozen of these stocks are yielding 8% or more. Of course I discarded the results of a few companies like Bear Stearns.  I think you might have a small problem cashing any dividend check they send you.

Now most of these high dividend yielders are in the financial industry.  I wouldn’t touch those with a 10-foot pole.  As I made my way down the list though I noticed a number of stocks with strong dividend yields from other industries.  Companies like Bristol Meyers (BMY), Dow Chemical (DOW), and a number of large REITs.

Here’s another interesting fact.

23% of the S&P 500 (about 115 companies) have dividend yields greater than 3%.  Looking a little closer, I found that these dividend numbers aren’t stagnant.  The average 5-year dividend growth rate for these stocks is more than 10%.  Not only do you get a great dividend yield now, but it should grow significantly over the next few years.
Dividend yield is more important than ever.  Give it a close look when adding to your portfolio.

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Category: Dividend Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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