By Steve Christ
With the constant drumbeat of bad news battering markets these days, the Federal Reserve now finds itself walking on the proverbial tight rope. And while some inflation hawks would more likely call it a plank, one thing at least seems certain--more rate cuts from the Bernanke Fed.
Of course, it is exactly times like this that investments in dividend stocks begin to rise. That's because as the Fed continues to cut rates and yields on U.S. treasuries are pressured lower, stocks with a steady history of dividend payments become increasingly attractive to yield-hungry buyers.
And with yields on the benchmark 10-year Treasury note hovering in the 3.8% range, and likely headed lower, dividend paying stocks will tend to outperform in 2008, while also providing a certain level of safety.
There is a reason after all, that these stocks are called "widows and orphans" investments.
But that doesn't mean that these stocks are only suited for the "retiree crowd". They are for any investor who is seeking to build great wealth with relatively low risk.
Even in bear markets, dividend-paying stocks typically do well, especially if those companies have a strong history of increasing the dividend payout.
That's because investors win two ways when a company increases its dividend. First, the yield on your initial investment goes up with the dividend, and even better, the dividend increase itself often propels the share price higher.
So What is Dividend Yield?
Dividend yield is simply your rate of return from the dividend payouts, exclusive of any stock price appreciation. It's calculated by dividing the dividends you receive over a year's time by the price you paid for the stock.
For example, your dividend yield is 5% if you paid $20 per share, and you receive $1 per share in dividends ($1/$20) over the 12 months following your purchase.
Dividend yield, however, is not a fixed number. It changes along with the share price. For instance, say someone else buys the same stock a week later when the share price had moved up to $25. Instead of 5%, their dividend yield would only be 4% ($1/$25).
In short, it is a cash payout that you receive for simply being a shareholder, sort of like receiving a bonus based on a company's earnings.
Moreover, these "bonuses" also offer lower tax rates than similar investments in savings, CDs or money market accounts. Thanks to a change in the tax law, dividends are now taxed at only 15%. That's considerably better than the 35%+ taxation levied against ordinary income.
Successful Dividend Stock Investing
Picking successful dividend paying stocks, however, is not as simple as buying only the stocks with the highest yield. In fact, it is usually the stocks with the highest yields that often trip up investors the most.
Instead, picking winning dividend stocks usually requires finding candidates with two qualities.
- They should have a minimal risk of a dividend cut.
- There should be a high probability that the dividends will increase while you own the stock.
Those two factors, of course, are exactly what makes dividend stocks related to healthcare so attractive these days.
That's because if there is one area of the economy that is bulletproof in regards to a recession, inflation, or worse stagflation, it has to be healthcare.
And when you add the prospect of 78 million graying baby boomers to the mix, the prospects for these types of investments is practically a no-brainer.
In fact, according to recent projections by the federal government, consumers and taxpayers will spend more than $4 trillion on healthcare by 2017 as our population continues to age.
The result is that healthcare spending will increase by 6.7% annually over the next nine years, outpacing inflation by nearly three times according to the forecast. In fact, it is estimated that by 2017 healthcare spending will cost an estimated $13,101 per person vs. today's average cost of $7,026 per person.
That, needless to say, will provide the type of environment that will keep those dividends growing.
Two Dividend Paying Healthcare Stocks
Here's two ways to play this trend in healthcare-related dividend stocks:
- Go Long Johnson & Johnson (NYSE:JNJ) - Sure this a "widows and orphans" all the way, but don't let that stop you because this is one great company with a demographic tide completely on its side. Moreover, their dividend history is as solid as it gets and is growing. Warren Buffet, by the way, is among its biggest holders.
- Go Long Omega Healthcare Investors Inc. (NYSE:OHI) - Omega is a real estate investment trust that provides financing and capital to the long-term care portion of the industry. The company owns or holds mortgages on 238 facilities with 27,465 beds operated by third party healthcare companies. Dividend growth at the company has been steady and consistent over the last five years.
But regardless of how you may choose to invest in this sector, don't think for one moment that dividends stocks are only for those that have the most to lose. Because the truth is that if you want to get rich with very little risk, dividend stocks are the best place to start no matter how old you are.