LESSONS FROM A LAZY AMATEUR THE NO-SWEAT WAY TO WIN WITH STOCKS: HOLD SHARES IN GOOD COMPANIES THAT PAY RISING DIVIDENDS.
By EDMUND FALTERMAYER REPORTER ASSOCIATE Ricardo Sookdeo

(FORTUNE Magazine) – THE STOCK MARKET is no place for the ignorant and the innocent, right? Isn't it a fact that even full-time money managers, ruining their eyesight on mounds of research, mostly trail the averages? True it is, and you're constantly reminded of it by people who are terrified of equities. Like an otherwise astute friend of mine with several million dollars entirely in CDs. Burned in the past, he wouldn't dream of risking his hard-won wealth in that jungle. He's dead wrong. Approached the right way, stocks are the best refuge in an inflation-prone world. Few have ventured in more benighted than I, nor am I able to spare more than a few hours a week. As for innocence, from the outset I forswore lusting after capital gains in favor of a wholesome goal that a jamboree of Eagle Scouts could applaud. All I wanted was to buy and hold a collection of good companies in the hope of securing a stream of dividend income that would grow fast enough to offset rising prices at the supermarket. Investing for income moves you to a more placid realm. You are a farmer quietly harvesting crops while elsewhere the gunslingers gallop to and fro in search of plunder. But guess what? So far, this particular farmer is ahead of most gunslingers. Income, my true love, has come through in grand style. Since 1982, without adding a penny to my stock portfolio, I have watched dividend payments climb 79%. As the chart shows, this more than compensates for a 35% rise in the consumer price index. The unexpected bonus -- don't worry, I'll take it -- is the capital appreciation. In the eight and two-thirds years through August 31, the market value of my holdings leaped 206%, while Standard & Poor's 500-stock index was up only 163%. This scarcely makes me an investing oracle, for luck has surely played a part, and the Nineties may not be as kind. But there is an enduring lesson here. If you look for companies that can raise dividends year after year without milking the operation, you will automatically be led to high-quality stocks whose value will sooner or later be acknowledged by the market. Finding the companies is not as hard as you think. Your main tools: common sense and a general knowledge of the business world, which you already have if you are a rising executive with spare money. I WAS FORCED to teach myself about stocks after my mother's untimely death in 1975. At that point, aside from the roof over my family, my wealth consisted solely of savings accounts and CDs. Suddenly I had to figure out something creative to do with a much larger chunk of money. Real estate was out. I didn't like the illiquidity and the possibility of midnight calls from freezing tenants. And what if the neighborhood deteriorated? Mutual funds turned me off: Prior to this time I had put some money in a no-load equity fund, which, with dividends reinvested, had rung up a blistering average return of 1% a year. True, a few genuine geniuses were making mutual funds blossom even in that era of market drought. But I didn't know enough about them to hand over my inheritance, and some charged 8% front-end loads that clashed with my tightwad tenets. So the only recourse was investing on my own. To my untutored mind, the choices quickly narrowed to two: long-term Treasury bonds, which would deliver risk-free income for 30 years, and stocks. If I went the equity route, I planned to practice what my father had preached: Look for good stuff at reasonable prices and, except for occasional fine- tuning, sit on it. That way my wealth wouldn't be riddled by the carpenter ants of capital gains taxes and brokers' commissions. Almost apologetically, I ran this quaint idea by a friend who invests megabucks professionally. We were riding the commuter train to work, and I expected him to warn with a sneer that I would be left in the dust by the big boys who breathtakingly shift money around to play the hottest new investing theme. Instead he said: ''Over time you'll probably do all right.'' I took that amazing nugget -- a pro admitting you could do without the pros -- as a marching order. To most laypersons in the late 1970s, an interest in stocks was a sign of a sick mind. Long-term Treasuries were paying 12% -- twice the average dividend yield on the Dow Jones industrial average. Investors were still scarred from the grizzly bear market of 1974. Surely Treasuries were the way to go. They were, except for one essential fact that had already caught my attention. If you grasp its full significance, you will probably be the first on your block who does. The coupon on a bond is fixed throughout its life, but dividends usually rise. Pity the poor bondholder, I reasoned then as now, for he is a moneylender forced to live on level interest income in a time of rising prices. Just as pitiful, he is repaid on maturity in dollars that buy less. The stockholder, to my way of thinking, was the one to envy. Unless his companies were troubled, he was like the owner of pear trees that yield more fruit each year. He owns a piece of assets both tangible and intangible -- factories, patents, marketing savvy, shelf space at the supermarket -- whose value rises over time, thus providing a hedge against inflation. So what if the market sometimes takes years to recognize this? If I went into stocks and planned to stay with them, I was not going to worry about daily, or even yearly, gyrations in their prices. When it comes to taking the long view, I make geologists look shortsighted. I realized, of course, that some experts take a sour view of investing for dividends. Profits paid out to stockholders, they argue, are doubly taxed. Those retained by the company can grow tax-free to the owners as shareholders' equity, which is not taxed until you sell out at a gain. But another school holds that companies ought to return some of their winnings regularly to the owners lest it be squandered on ill-considered ventures. This view was more to my liking, for I wanted income now. Seen through my maverick eyes, the trade-off between Treasuries and stocks looked positively dreadful. Consumer prices were shooting up in the late Seventies, turning that 12% bond coupon into a negative return after inflation and taxes. Just to preserve the real value of your nest egg, you had to kick in extra money each year. As for stocks, the dividend yield was admittedly puny -- less than 4% after taxes. But income that grows, my dears, is worth more than income that doesn't. It is only right that for the same investment you should get less -- at first. And hear this: By now the yield on what I originally committed to stocks is up to 12.5% and still climbing. About this time, two developments turned me into an equity zealot. I noticed that Kellogg Co. was able to keep hoisting the price of my favorite cereal. Later, after I had bought the stock, I would learn that the company, with its strong market franchise, enjoyed what professional investors call pricing flexibility. Stock in such a company, I decided, would be a dandy escalator to ride. If the dividend checks merely swelled in sync with the price of Special K, I could laugh at inflation. The real moment of conversion, which I dare to liken to Saul's journey to Damascus, came when I examined what had been happening to my mother's income while she was still alive. My siblings and I had shared a nightmare common to those with elderly parents: that steeply rising bills at her nursing home would quickly catch up with her relatively ''fixed'' income from trusts. THESE trusts, however, were mainly invested in stocks. I knew enough to turn to the Value Line Investment Survey, the most useful investor's tool ever invented. I was able to calculate how income from one of the trusts would have fared over the period from 1962 to 1977. The overall cost of living had doubled. But the dividends paid out on the stocks -- hallelujah! -- had climbed slightly faster than the CPI. The only question now was which stocks to own. It was easy to decide what I did not want. These included siren stocks with double-digit dividend yields. The yields are high because the market is leery, meaning that the dividend is endangered. I also nixed companies with flat revenues and earnings, those that shortchange research and capital improvements to gratify shareholders, and those seriously threatened by Asian competition. Bad management or labor relations also took a company off my list, as well as a narrow product line that could be rendered obsolete by technological changes. In effect, I was on a quest for worry-free companies. And why not? I was a lazy investor who wanted to sit back, the counterpart of the author of the I Hate to Cook Book. This attitude ruled out even Merck, one of the stocks I inherited. How could I know that it would climb 700% during the 1980s? All I could see then was a company heavily dependent on new drug discoveries, which didn't seem worry-free at all. So I unloaded it along with some other stocks that had come to me from terminated trusts: CIT Financial (later bought by RCA in a windfall I missed); Fidelcor (since merged into New Jersey's First Fidelity bank); Du Pont, Hercules, and Union Carbide (chemical companies whose cyclicality flunked my litmus test), and Pennsylvania Power & Light (in a state with fairly tough regulators). In my purchases I followed a three-pronged strategy reflected in the table below. Shown is a prorated cross section of my holdings at the end of 1981, when I had just ceased transferring cash to fatten the portfolio, and at the market close on August 31. The cross section allows me to use an initial figure close to $100,000, a convenient number in examples of this kind, and to show most of my holdings in round lots. I made most of my moves, be it noted, before I began editing FORTUNE's Personal Investing column in late 1982 and stopped being ignorant. One part of my strategy was to maximize dividend income right away, in case a great idea for a novel came to me. So I added to my holdings of Exxon, a generous check writer, and bought American Home Products (since sold) and several utilities. One of my stars is Southern Indiana Gas & Electric, which operates in a state where they don't kick around power companies and which produces not one troublesome watt of nuclear power. Another is Bell Atlantic. After the AT&T breakup I consolidated my Baby Bell holdings into this one, said to be one of the more efficient regional phone companies, and bought more. I haven't done quite as well as I would have holding the whole litter of Babies. Generous companies tend to be mature ones. That dictated a second strategy of buying some growth stocks: IBM, Johnson & Johnson, 3M, and Procter & Gamble. Because of the high quality, the yields were initially small but promised to grow mightily down the road. IBM ran into an earnings downdraft, and the dividend has only inched up. But the yearly checks from Johnson & Johnson, at first only 2.6% of the price I paid for the stock, have grown more than fourfold in 11 years. And in 1989 alone, 3M boosted its payout 22.6%. Somewhere in between fell three companies that formed the third leg of my strategy. They offered above-average dividends with tolerable growth and safety and, more important, they were not in vogue. I added to my holdings of CoreStates Financial after I saw its earnings ascend steadily and discovered that this top-quality bank has few Third World or energy loans. Value Line was already saying good things about Heinz, and my brother-in-law, who sold industrial cranes, had been impressed by one of its plants. In Heinz sight, the ketchup king proved my best performer, recently worth ten times what I paid for it in 1978. There's also nothing slow-pouring about the dividends -- up 240% since 1982. That's what I talk about first when the subject of investment performance comes up. Few things are more satisfying than seeing my mailman arrive with quarterly checks that are bigger than last year's. It's like getting a raise while you sleep. Out of more than 700 checks addressed to me since the late 1970s, not one has been lost. I am not a critic of the U.S. Postal Service. IF PRESSED, I am prepared to discuss that tiresome little matter of capital gains. These are almost entirely on paper, but the demon of competitiveness stirs in every breast. In the spirit of telling the whole truth, I should point out that my showing is less impressive if the starting point is August 12, 1982. That's the eve of the great bull market of the Eighties, when the Dow had reached a low of 776.92. From then through the end of August my stocks were up 224%, only nine percentage points more than the S&P 500. Carping types would conclude that I have kept only slightly ahead all that time. But there's more to it. My portfolio is less volatile, having fallen less between the end of 1981 and the final days of the 1982 bear market; it also hangs back at market peaks, including the all-time high of July 16, 1990, when the Dow brushed 3000. Even with the 1982 low as a base, I've done better than it might appear. The dividend yield on my portfolio -- 4.06% based on the August 31 close, vs. the market's 3.78% -- widens my edge when total return is taken into account. And I've saved on the management fees I would have paid to a mutual fund, typically 1% of assets yearly -- perhaps a fourth of dividend income. Aside from occasional commissions at discount brokerage firms and maybe $10 a year for registered mail, my expenses have been zero. I have also avoided unwelcome taxable capital gains distributions from mutual funds, which are more prone to switch stocks than I am. And meanwhile, the mailman keeps on coming . . .

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: The author bought stocks in hopes that his dividends would outpace inflation. These charts, based on a prorated slice of his holdings, show that he also outran the market. DIVIDEND GROWTH WAS THE AIM... Yearly portfolio dividends ...BUT THE CAPITAL GAINS WERE NICE TOO Author's stock portfolio

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: MORE CHAMPS THAN CHUMPS The stocks in this cross section of the author's portfo lio are ranked by their performance during the eight and two-thirds years through August 31, or while held. Total brokerage transactions throughout the peri od: a leisurely 14. Takeover windfalls: none.