One thing you will learn in investing is that nothing is ever absolute and that rules are made to be broken. With that said, I’ve been giving a lot of thought as to what stocks to buy this year and my previous declaration to use the Dogs of the Dow strategy.
As I get closer to actually making a purchase, I’m starting to reconsider my initial plan and may have an alternative solution that would make more sense. Here’s is where my mind is at:
Why I Want Dividend Paying Stocks:
First of all, the core of my plan has not wavered from going after dividend paying stocks. Fundamentally the concept still makes great sense to me!
When I think about which stocks to buy from all the choices out there, I want high quality companies with strong earnings potential that are going to pay me some guaranteed rate of return regardless of how much the market price changes – hence the dividend payment. But that’s not my only reason for liking dividend stocks.
The dividend yield of a high quality company tells you something about the market price. Observe:
As you can see, if a solid company either holds or increases their dividend payment, then a higher than average dividend yield may indicate that the share price is likely to be undervalued in the market. This could mean that it is a good opportunity to buy!
The key here is to invest in SOLID companies – not just ones that arbitrarily raised their dividend yields overnight so that they look good to investors on paper. The long term ability of a company to make their dividend payments quarter after quarter is a sign of financial strength in a company; a quality most of us would find appealing for an investment.
This is why the Dogs of the Dow strategy has so much appeal to me, and why I have declared in previous dividend updates that I plan to use it as my simple answer as to what stocks to buy next. Rather than sifting through thousands of choices, I can conveniently cut straight to the Dow Jones Industrial Average to pick the highest dividend yields among the largest 30 stocks around.
But are things really so black and white? If there is one thing we encourage you to do here on My Money Design, it’s that no one looks out for your money the way you do. You need to use your own head to make a decision. Myself included!
So rather than just blindly following this strategy, I decided to dig a little deeper and see what exactly I’d be getting for my money.
Taking a Closer Look at What Stocks to Buy This Year:
If I go to the Dogs of the Dow website, I can pull the stock symbols of the current ten Dog stocks. I can then quickly copy that information into Google Finance and gather a ton of useful information about the Dogs. Sorted by dividend yield, we have:
Earnings per Share (EPS), Price to Earnings (PE) Ratio, and Price to Book (PB) Ratio are all good figures for how to read stocks. But the metric I really like to pay attention to is Return on Assets (ROA). Using ROA was the conclusion of the book “The Big Secret for the Small Investor” by Joel Greenblatt. It’s powerful because, unlike other stock metrics, it takes the stock price right out of the equation. It looks at only the hard numbers of the company performance:
1) Net income, and
2) The assets of the company.
In other words, how efficient was the company in their ability to make more money with less assets? As you can guess, higher is better. Negative means the company is actually losing money.
So as I look across the Dogs, I see that the last one Hewlett Packard is in fact losing money! A closer look using the stats provided on CNN Money indicate that the 5 Year Earnings Growth forecast as well as the 12 Month Price Forecast are also both sour.
(I don’t consider these two metrics to be hard requirements since they are merely analyst predictions, but they can still be helpful in your valuation. Just for good measure, all of the other nine stocks in the Dogs pass the sniff test of having positive Five Year Earnings Growth forecast and 12 Month Price Forecast.)
So if my fundamental goal is to invest in SOLID companies with strong earnings potential, would I be accomplishing this by investing in Hewlett Packard? I’m afraid the answer leans towards no.
Therefore, I can’t in good faith just blindly follow the Dogs of the Dow strategy. My decision as to what stocks to buy needs a little further investigation.
Using the Dividend Aristocrats to Complete the Puzzle:
The Dogs aren’t the only kids in town that pay good dividends. There is another group of popular stocks known as the Dividend Aristocrats (tracked by the S&P). These are companies that have increased their annual dividend payments for at least 25 years. 25 years! Think about how much commitment and financial stability that would take for a company to be able to do this through the thick and thin of 25 years!
So if we consider using one of the Dividend Aristocrats as a substitute, let’s do the same analysis as above to see what stands out. Again we put the ticker symbols into Google Finance to retrieve all their information. Sorting the results by dividend yield, here are the front runners:
Right off the top, we see that Pitney Bowes has an ultra attractive +12% dividend yield as well as decent ROA and Beta. So what’s going on here?
A closer look shows that the market price has gone down-hill A LOT as it is near the bottom of its 52 week range. Apparently the company has had some hard times over the past few years.
But that doesn’t mean we pass it up just yet. Consider:
- The fact that it is an Aristocrat means that they haven’t stopped paying or increasing their dividend payment for over 25 years
- The Earnings and Share Price Forecast show signs of optimism.
Clearly there is some potential for a come-back from this company. Even if they experience a mild amount of slow growth, a 12% yield would certainly make it all worthwhile!
But I throw the question to my Readers: Do you think taking a chance on Pitney Bowes over Hewlett Packard would perhaps complete my quest as to what stocks to buy this year? Are there other stock picks on this list you think deserve a second look?
Image courtesy of renjith krishnan / FreeDigitalPhotos.net