CHAPEL HILL, N.C. (MarketWatch) — So you’ve finally decided to heed the oft-repeated advice to invest in dividend-paying stocks.
Now what?
It turns out that you still have an overwhelmingly large number of stocks to choose among. In 2012, for example, more than 400 of the 500 stocks in the S&P 500 index SPX, +0.67% paid dividends — or more than 80% of them.
Telling me to confine myself to just the dividend-payers, therefore, doesn’t narrow my buy list down to a helpful number.
The best way of going about constructing a portfolio of dividend-paying stocks, based on the Hulbert Financial Digest’s monitoring of more than 500 separate strategies, is to follow the methodology employed by Investment Quality Trends.
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This service, inaugurated by Geraldine Weiss more than four decades ago and currently edited by Kelley Wright, doesn’t simply recommend the dividend stocks with the highest yield. The service instead focuses more narrowly on the bluest of the blue-chip dividend-paying stocks, and recommends one of them only when its yield is near the high end of its historical range.
The service’s restriction to just the bluest of blue-chip companies is designed to avoid companies at which the dividend yield is only temporarily high — firms that are about to cut their dividends, in other words.
Specifically, Wright puts a stock on his watch list only if it satisfies at least five of the following six criteria:
- Has increased its dividend at least 5 times over the last dozen years
- Has an S&P Quality Ranking in the “A” category
- Has at least 5 million shares outstanding
- Has at least 80 institutional investors
- Has paid dividends for at least 25 straight years
- Has produced higher earnings per share in at least 7 of the last 12 years
The service’s focus on relative dividend yield is a recognition that each company has a different baseline. A utility company, for example, may still pay a much higher dividend yield than other companies, even when that yield is lower than its baseline — and when, therefore, it more likely than not is overvalued.
How has this approach performed? Over the last 12 months, for example, it has outperformed all of the major dividend-oriented ETFs. The average portfolio from Investment Quality Trends has gained 16.9% over this period, according to the Hulbert Financial Digest.
Better yet, this superior return was produced with nearly 20% less volatility, or risk — which means its performance on a risk-adjusted basis is even better than the raw numbers already suggest.
Its record over the longer term has also been impressive. Over the 25 years the Hulbert Financial Digest has tracked it, it has beaten a buy-and-hold by one percentage point per year on an annualized basis, while nevertheless incurring 14% less risk.
Investment Quality Trends currently is in third place for risk-adjusted performance over the last 25 years.
Which high-quality stocks are currently recommended by this approach? The following is Wright’s “Timely Ten” list of his top 10 current recommendations:
- Archer-Daniels Midland ADM, +0.44% : 2.4% yield
- CVS Caremark CVS, +0.08% : 1.7% yield
- Cardinal Health CAH, +0.39% : 2.5% yield
- Coca Cola KO, -0.82% : 2.7% yield
- ConocoPhillips COP, +3.25% : 4.3% yield
- Johnson & Johnson JNJ, -0.56% : 3.3% yield
- McDonald’s MCD, -0.80% : 3.3% yield
- Occidental Petroleum OXY, +1.42% : 2.5% yield
- Reliance Steel RS, +1.33% : 1.6% yield
- Union Pacific UNP, -0.03% : 2.1% yield
This package of 10 stocks not only has an average dividend yield of 2.6% but, Wright is convinced, has good capital-appreciation potential in the event of a continuation of the bull market, and healthy downside protection in the event of a bear market.
