Why, At 28, I'm Going With Dividends

 |  Includes: AEO, DOV, JNJ, MMM, MSFT, NFLX, TGT
by: Pey Shadzi

Recently, at my ten-year high school reunion, I sat down with a few beers and a group of my high school buddies. After reminiscing for about an hour or two about the "good 'ol days" and how much trouble we often found ourselves in, the conversation inevitably drifted towards investing. Seeing we all grew up in the era of The Great Recession, it never hurts to plan for the future, right?

"What are your strategies? Which companies are looking good? Which ones are you buying? Have you checked out this one?"

I'll admit it: despite only being 28, I often loathe talking with younger investors about strategies because, after hearing I'm a value investor who seeks high quality, dividend-paying companies, they often begin instantly grilling me questions:

"Buy why dividends? You're too young to be an income investor! Don't you know growth stocks are better suited for young people?"

I'm here to tell you, fellas, that dividends aren't just for Warren Buffett and retirees. Dividends have the power to support your goals of becoming independently wealthy.

Here are three reasons why:

  1. Companies that pay dividends usually have more money than they know what to do with. Ironically, when a company dishes out billions of dollars to investors annually in the form of dividends, you might consider they're making too much money. In other words, their profits are so juicy that they're free to distribute excess cash to one of their most prized possessions: you, the shareholder. Target (TGT) has been paying dividends every single year since 1965. They've been raising their dividend annually for nearly 45 years. Now that's commitment.
  2. Companies that pay dividends are often here to stay. Sure, there are a few exceptions, but for the most part companies with long, sustainable histories of paying dividends, such as 3M Company (MMM), are more reliable than younger companies like Netflix (NFLX) or Joe's Jeans (JOEZ). You can think of it this way: Who would you trust to show up to work tomorrow? Walter, the 56 year old janitor who hasn't missed a day in 30 years or Slater, the 22 year old hotshot lawyer who just graduated from an Ivy league and landed a job at the firm? Reliability is often a difficult thing to come by in this day and age.
  3. Companies that pay dividends may even outperform while exhibiting an investor to a much lower risk profile -- especially if reinvested dividends are considered. Not a day goes by where I don't hear someone refer to the last ten years as "the lost decade." Well excuse me if things didn't go well for growth investors, but owners of quality, dividend-paying companies, such as Johnson and Johnson (JNJ) actually fared quite well. In addition to a capital appreciation of about 12% over the last ten years, JNJ managed to grow their dividend from $0.20 a share per quarter in 2002 to $0.57 a share per quarter in 2012. Not too shabby when you think about it.

Here are three companies I own that I recommend you look into:

  1. Microsoft Corporation (MSFT). Trading at just nearly nine times next year's earnings with a dividend near 3% and a payout ratio of only 23% is the software giant Microsoft. I may own just about every Apple product out there, but I also know better than to ignore an amazing company like Microsoft which, by the way, had a revenue over $71 billion for the last four quarters. The financial outlook looks incredibly strong for a company estimated to pull in $3.04 per share in 2012 with over four times more cash on hand than debt.
  2. Dover Corporation (DOV). Though Dover is a company you may never have even heard of, they're certainly a company you shouldn't ignore. Based in Downers Grove, Illinois, this dividend aristocrat is a diversified industrial, engineering, electronics and fluid management company who has been increasing their dividend for over 50 years. With a forward P/E of around 12, a dividend yield of about 2.2%, a payout ratio of only 27% and annual revenues of over $8 billion, Dover warrants a second -- or first -- look. DOV is an excellent choice for younger investors who would not only like to see a high potential capital appreciation but would also like to collect a dividend along the way.
  3. American Eagle Outfitters (AEO). If I only had one choice in the retail sector, I'd go with AEO. Coming off nearly a 12% drop over the past month and only roughly 30% off its five year low, AEO sports a forward P/E of about 12, a dividend yield of 3.3%, a payout ratio of 46% and about $500 million in cash with no debt. Teenagers are a fickle bunch, but a company without debt and a good load of cash on hand will be able to weather any unpredictable storms -- such as a rise in cotton prices or a sluggish economic recovery -- better than another retailer spending like there's no tomorrow. AEO warrants a closer look.

So if you're a younger investor out there like me who happens to have a discussion with his buddies about investing while at the poker table, don't let them pressure you into any particular investing strategy. Though not necessarily as "sexy" as growth investing, take a look at the world of dividend investing and make sure to keep an open mind. I did and what can I say? I'm hooked.

Disclosure: I am long MSFT, MMM, TGT, JNJ, AEO, DOV.