Welcome to Ameritrade Plus University |
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We all want a stock that will double overnight. But there's something to be said for steadily rising dividends. "Show me the money" is the cry of income investors. They don't want to bet on explosive earnings growth or higher valuations. They want safe, reliable cash payouts that rise faster than inflation. There's a good case for including income investments in any portfolio, because they can add a little ballast when stock prices go south. There are plenty of income vehicles, but shares of companies that pay dividends have an important advantage over many of the alternatives. Bond payouts don't increase over time, for example, but dividends do rise for most income stocks. Historically, blue-chip stock yields have averaged around 4 percent. And most of the time they've ranged between 2.8 and 5.4 percent, with a few exceptional periods. We're in one of those periods right now, with the yield on the S&P 500 well under 2 percent. Nonetheless, even in this market it's possible to find stocks with yields of 3 percent or more. You shouldn't focus on today's yield, however, and ignore everything else. The dividend growth rate is equally important. A stock raising its dividend 6 percent a year will double its payout over 12 years and quadruple over 24. If you hold long enough, even a stock with a modest yield could end up paying out far more than you could earn with a bond. To evaluate an income stock, you should consider the current yield and the likely dividend growth. Since dividends usually increase more or less in line with earnings, you can gauge a stock's long-term potential simply by adding the growth rate to the current yield. If a stock has a 3.5 percent yield and 6 percent annual earnings growth, for instance, its long-term return is likely to average about 9.5 percent. You can compare that total return estimate to the yield available on bonds. If you figure that high-quality bonds pay as much as 7 percent or 8 percent, income stocks will need potential total returns even higher to be top choices. Many good utilities -- including electric, gas and water companies - clear that hurdle. The big risk to any income investment is an upsurge in inflation. You should therefore award extra points to any income investment that incorporates an inflation hedge. Oil stocks and mining shares, for instance, would benefit from any increase in raw materials prices and some of them pay fairly high yields. Similarly, real estate investment trusts profit from rising property prices and some REITs pay yields of 7 percent or so. That's a whole lot more than you'll earn in a money-market fund. | ||
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