Dividend stocks are a great way to invest over the long term. If you are going into retirement, the dividends are a nice quarterly source of income. And, as you prepare for retirement, dividend reinvestment plans let you roll your dividends back into more shares of stock without paying any commissions. But, not all dividend stocks are created equal! All too often, companies that are struggling maintain their dividend. The stock price is down and the dividend yield is fantastic. But, some of these high dividend yields are dangerous. One day the dividends will disappear just as the struggling company goes out of business! Here are a few of our thoughts on choosing the best dividend stocks.

Finding Dividend Stocks to Invest in

It is easy to find dividend stocks. But, rather than looking first for stocks on Yahoo Finance or Google Finance, go to a site like Dividend.com for a huge list of dividend stocks and Macy’s on page 22 paying a 9% + dividend. They are preceded by stocks that pay for more than 100% of the share price. When you see a stock like Macy’s that is having trouble competing in the brave new world of online sales and Amazon.com, you can understand why they are keeping their dividend up to attract investors even as sales and income fall. But, when a company is listed as paying more than the share price, something is drastically wrong. You should think twice before buying Macy’s for the dividend but when you see stocks with ridiculously high dividends, it is time to run and hide! So, how do you go about choosing the best dividend stocks that reward you for investing while also being safe over the long term?

Choosing the Best Dividend Stocks

There are just a few rules to follow in order to find the “goldilocks” group of dividend stocks that provide excellent returns and are secure over time. The process looks a lot like assessing intrinsic stock value when investing in stocks.

Investing in Dividend Stocks with a Large Margin of Safety

Some refer to this a looking for a strong operating mote. Whether this is a “high cost of entry” business like a natural gas pipeline that has overcome numerous obstacles to get built, a utility that is licensed to serve a specific region, or a world famous trade name like Coca Cola, companies that these competitive advantages are likely to be secure investments and dividend cash cows for year and years.

When Investing, Stay with Dividend Yields That Match Those of the Competition

This gets back to the business of avoiding companies that are struggling and don’t want to reduce their dividend for fear that it will alert investors as to their dire straits. A healthy business in any given sector will typically pay dividends in a given range. When the dividend is higher or lower than expected, you need to check that out before investing.

Understand and Check Out the Payout Ratio before Investing

This is similar to being leery of too-high dividends. A company will typically pay out a set portion of its income in dividends every year. The dividend goes up as they make more money and the dividend should go down when they go through difficult times. The market may not have caught on that a company is having trouble or doing better than expected, but if you follow their payout ratio, you will have a good idea. Then you can make an intelligent decision to buy more of the stock, hold what you have, or sell before the bottom falls out. Likewise, if you are putting your money in a stock and want to sleep well at night, you want a company whose balance sheet is healthy.

Investing Companies with Increasing Dividends

Companies that have been paying in dividends for decades or even more than a century have typically been increasing their dividend over the years. This is a sign of a healthy business, a good margin of safety, and intrinsic stock value. Picking stocks whose business plans you understand and who dividends go up every few years is a good way of choosing the best dividend stocks without spending too much time looking at the details!

These stocks have both short-term gain catalysts and longer-term growth potential.

We’re still experiencing a tale of two markets as we round the corner for the final week of August – while the S&P is up a bit over 5% year-to-date, nearly half of the stocks in the big index are actually up 10% or more since the calendar flipped to January. Simply owning more of the stocks that are working in this environment and fewer of the ones that aren’t could hold the keys to substantial outperformance this year.

These folks pick their so-called rocket stocks based on consensus upgrades by analysts and surprises in earnings. Their rationale is that when a stock is liked by analysts and shows a surprise uptick in earnings institutional investors tend to pour money into them driving up their stock prices.
Their 5 rocket stocks for the week are Facebook (FB), Illinois Tool Works (ITW), Haliburton (HAL), Constellation Brands (STZ) and Best Buy (BBY).

But, is this the best way to pick top stocks?

Top Stocks for the Short and Medium Term

The approach used by The Street is useful for picking top stocks in the short term. Here is an example of why this works.

Years ago an investor friend of mine used a simple strategy to pick short to medium term winners, so-called top stocks. In the days before Barrons was posted online he would purchase a copy each Saturday morning. He would look to see if there any articles by stock analysts and if they made a decent argument for why to purchase a stock or two. Then he would call his stock broker (pre internet days) and buy one, two or three stocks from the article. His cut off for profits was 30% and his cutoff for losses was 10%. Almost invariably these stocks that were talked up in Barrons went on a multi-week run as long term investors decided these were good investments based on the article and based on the fact that the stocks almost immediately started to rise. Over the longer term the stocks that were hyped in Barrons did not always do well. Taking a 30% profit on almost all of the stocks and absorbing a 10% loss on a few was a good strategy and profited my friend for years.

For the longer term picking top stocks and why you choose them has more to do with strong fundamentals and picking such stocks when the market corrects and takes all good stocks with it. We wrote a year ago about how to identify first signs of a market correction. When the market is overvalued by historic standards, like today, the first step is probably to pick stocks based on strong fundamentals and tag them for purchase when their price falls and their intrinsic value rises.

Top Stocks to Buy and Why PPT

For the 38 years between 1975 and 2013 a $100 investment in the average home (as tracked by the Home Price Index from the Federal Housing Finance Agency (FHFA)) in 1975 would have grown to about $500 by 2013. A similar $100 investment in the S&P 500 over that time frame would have grown to approximately $1,600.

If you are interested in making your money work for you over the long term, how do you start investing in the stock market? The first step is to take a look at your finances and your expenses. In fact how to start investing in stocks is to get your financial house in order first and then start picking stocks.

Pay off Your Credit Cards!

If you have credit card debt you are paying between 13% and 20% a year on what you own the credit card company. It is difficult for an investor to routinely make this kind of a return on stocks so your first move should be to pay off your credit card debt.

You Need a Place to Live

It will cost you less over the long term to own your home than to rent. And the interest on your mortgage is tax deductible.

A Rainy Day Fund

It is all too common get trapped in a job with no future because you have no cash reserve. And it is all too common to lose a job and not be able to find one for six months to a year. Regarding investments you do not want to have to pull money out of a stock investment just as the market retreated. So, before picking stocks it is wise to have six months-worth of living expenses in the bank.

Now It Is Time to Pick Stocks

As you start investing in the stock market think about you goals. Do you want to save for retirement? Are you putting money aside to pay for your child’s college education? Are you looking to make lots and lots of money and are you willing to take on the risk that goes with aggressive investing?

Last week we wrote about how to pick dividend stocks. These are stocks that you will buy and probably hold until retirement and after. They will appreciate some in value and they will pay you a dividend every quarter. A conservative investor will load up on these stocks whenever they have money to invest.

The ideal growth stock is in a new market. The classic example is Microsoft. Paul Allen and Bill Gates founded the company in 1975 and took it public in 1986. If you had purchased 100 shares at $21 each at that time you would now have 28,800 shares after nine stock splits. Today the stock sells for $53 a share making your total holdings worth $1,526,400. And you would be receiving $40,320 in dividends every year. The obvious choice if you want to make tons of money is to pick the next Microsoft. Your best bet for doing this is to invest in stocks of companies that you know something about. Look for low price to earnings ratios of solid companies. And invest in a sufficient number of startups so that you increase your chances of hitting a home run while seeing several of your start up bets go out of business. In the end the best approach is to diversify your investment portfolio with a mix of conservative and aggressive stock picks.

How Do You Start Investing in the Stock Market? PPT

Stay with What You Know: Picking Stocks

Picking sound investments stocks or otherwise, may simply be a matter of keeping your eyes open. A now-famous investor went to the mall with his wife and two daughters. The girls dragged their parents to a new store that was packed with adolescent females buying sweaters, blouses, slacks, etc. The father was impressed by how much business the store was doing and investigated the stock. It was the Gap. This stock sold for nine cents a share adjusted for stock splits and now sells for $40 a share. The same investor, Michael Lynch, noted that in the late 1970s the popular investment for physicians was railroad box cars which they would then lease to railroads. This turned out to be a bad idea and many docs lost money. At the same time Smith-Kline-French marketed the first effective drug to treat heartburn and peptic ulcers, Tagamet. This drug was sold in huge quantities and SKF stock went up. This is where the basics of successful investing dictate that you invest in what you know or what you see and do research on. Dads who invested in Gap in the early days made money and so did docs who invested in SKF and ignored an investment (railroad box cars) about which they knew nothing.

Choosing to Invest or Not: Intrinsic Value

One of the basics of successful investing is intrinsic value. This concept was introduced by Benjamin Graham in the aftermath of the 1929 stock market crash as part of the concept of value investing. The idea was to develop a rational means of investing in stocks. Intrinsic stock value is its fundamental value derived from solid numbers and not the current stock price which is often driven by current market sentiment. If the intrinsic value of a stock as calculated by the Graham formula is higher that its market value the basics of successful investing dictate that you buy the stock. If the reverse is true you sell the stock if it is in your portfolio. The Graham formula considers earnings per share, a five year growth estimate and the current rate of interest on AAA corporate bonds. Here is the formula as updated by Graham in 1974.

V = (EPS x (8.5 + 2g) x 4.4)/Y

• V is the intrinsic value.
• EPS is earnings per share.
• G is the expected five year growth of the company.
• Y is the current yield on AAA corporate bonds.

To use the formula do the calculation and then divide the calculated intrinsic value of the stock by its current price. The result is called the relative graham value or RGV. If the RGV is less than one the stock is overvalued and a bad investment and if the ratio is above one it is undervalued and may be a good investment.

Look for article III about the basics of successful investing next week.

Basics of Successful Investing II DOC

Basics of Successful Investing II PDF

Basics of Successful Investing II PPT

More Resources

There are many ways to get penny stock leads. For example, searching the internet (blogs and forums), joining a penny stock mailing list or keeping an eye out on the news. The main idea is to build a list of around 5 to 10 quality leads that are worthy of your money.

After you have a list of leads, you’ll want to choose one or two of them. You’ll need to go through your list and discard stocks which do not meet your criteria. This process can be tedious but it will be well worth it in the end.

The criteria to look for includes – company history, business plan, opinions of individuals and experts, financial information, competition, track record of the board of directors, company reports and broker recommendations. Using the variables, you can quickly establish whether a particular stock is worth investing in.

Once your list has been cut down to 1 or 2 stocks, ask for opinions from other people to confirm your selections. It is very important to listen to the views of other investors because, in most cases, they’ll have something valuable to contribute to your research. Perhaps, you missed out a vital piece of information which other investors could highlight for you.

Now that you have 1 or 2 stocks out of your original list of 10, you should feel confident that you’ve done your due diligence and you should be ready to invest. If you use this process every time you’re investing in penny stocks, it should prove to be simple but profitable.