Q: I am more interested in investing for income over the long term rather than in participating in the daily ups and downs of the stock market. What would be a good investment strategy for me?
A: One choice for income seekers may be quality, long-term, dividend-paying stocks. Many “name brand” companies have not only paid dividends consistently since the early 1900s, in some cases, they also have steadily raised their dividends.
Q: What makes these stocks attractive to long-term investors?
A: Consistent dividend growth stocks may be attractive for long-term investors who can hold the stocks as dividend payments rise. Although the stocks’ current yields may not seem competitive at first, growth in dividend payments can significantly increase the yield on an original investment.
Q: Why is dividend growth so important?
A: An investor seeking income could purchase conservative fixed-income investments, such as Treasury bonds. In fact, every well-balanced portfolio should contain such investments. However, without the power of dividend growth, inflation will take its bite, and these investors may end up losing ground to inflation over time.
Q: What should I look for in a quality stock?
A: Consider three factors that can help limit your risk and keep your income growing when you are looking for income among stocks:
1. A low payout ratio gives the dividend room to grow. The payout ratio is the percentage of a company’s earnings per share (EPS) paid out as dividends in the current year. The lower the ratio, the more room for potentially boosting the dividend. Remember, for a leading company to retain its leadership position, it will have to channel a good portion of its earnings toward growth. Thus, payout ratios may be lower for these stocks than they are for electric utilities or other companies in slow-growth industries.
2. Capital appreciation potential can enhance returns. Regardless of whether or not they receive a dividend, most investors buy a stock hoping its share price will rise. Consider how the value of your investment would increase if, in addition to annual dividend increases, the company’s stock price also rose, for example, in line with the S&P 500 average.
3. Dividend payment history can provide clues about the future. Although past performance does not guarantee future results, a company with an unbroken record of paying dividends for 30-plus years would seem to be reliable for income. A history of growth in the dividend is equally important.
However you choose your income stocks, the key is holding them for the long term, which means that daily and monthly price swings may not be as important. Remember that time in the market, not timing the market, is most important to investment success.
(Kirk Aguer is a financial advisor for Morgan Stanley. To reach him, call him at his Santa Monica office at (310) 319-5220.)
