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Introduction:

Over the last few weeks, I've had some extra time on my hands and as a result, I have become a voracious reader of articles on Seeking Alpha. I love finding authors that are new to me. Being a Dividend Growth investor, I spend a lot of time in the "Dividend and Income" section of SA and recently there have been some articles posted in that section that have really been interesting.

One article in particular struck a nerve with me. It was titled, Why Dividend Stocks Will Significantly Lag Cyclicals Over The Next 5 Years.

The author of that article followed up with two additional articles, with much the same point of view. Dividend Growth investing is not where you need to put your money today. Instead, he argues, cyclical stocks like General Electric (GE), Caterpillar (CAT), Chevron (CVX), Exxon (XOM), Boeing (BA), and financials like JP Morgan (JPM) and Citi (C), should be among your new investment choices.

In a nutshell, the author was pointing out that traditional dividend paying stocks have held up nicely, year to date, relative to some of the cyclical stocks, which were down 15% or more, price wise. The argument is that some of these cyclical stocks seem to have more upside potential than the non-cyclical stocks, like Kimberly Clark (KMB), Walmart (WMT), Kraft (KFT), AT&T (T), and Altria (MO). He warns us that DG stocks are selling at historically high PE ratios and that these companies are in for trouble ahead.

The two threats to DG stocks, as the author sees it, are: first, the potential of increased taxes on dividends at some point in the future and second, the declining value of the dollar and slow economic growth ahead.

What You Need To Know:

At one of my favorite sites, Investopedia, there is a simple definition of cyclical stocks:

An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies that sell discretionary items that consumers can afford to buy more of in a booming economy and will cut back on during a recession. Contrast cyclical stocks with counter-cyclical stocks, which tend to move in the opposite direction from the overall economy, and with consumer staples, which people continue to demand even during a downturn.

Cyclical stocks rise and fall with the business cycle. This seeming predictability in the movement of these stock's prices leads some investors to try to time the market by buying these stocks at the low point in the business cycle and selling them at the high point. Examples of companies whose stocks are cyclical include car manufacturers, airlines, furniture retailers, clothing stores, hotels and restaurants. When the economy is doing well, people can afford to buy new cars, upgrade their home furnishings, go shopping and travel. When the economy is doing poorly, these discretionary expenses are some of the first things consumers will cut. If a recession is bad enough, cyclical stocks can become completely worthless as companies go out of business.

The economy is not, by any stretch of the imagination, growing at a pace that would indicate that we are "out of the woods." Some would suggest that we could possibly find ourselves in a double-dip recession in 2013.

With that in mind, how can you argue that cyclical stocks are a place to be investing your money, today, based on the definition of a cyclical stock as mentioned above?

Here's What I Know:

As a Dividend Growth investor, I use a very simple set of criteria for my investing strategy:

  • First, I want to purchase stock in companies that have a history of increasing dividends on an annual basis and that have done so for a minimum of 5 years.
  • Second, I want to look at the dividend growth rate and find companies that are growing that rate faster than the rate of inflation.
  • Third, I want to make sure that the companies that I invest in have the earnings power to continue paying those dividends as we move forward.
  • Fourth, I want to buy stock in those companies at what I perceive to be a discount to intrinsic value.

Over the years, consumer product companies like Coca-Cola (KO), Kimberly Clark , Colgate Palmolive (CL), Johnson and Johnston (JNJ), Abbott Labs (ABT), Procter and Gamble (PG), and McDonalds (MCD) have been favorites of mine. The reason that they are favorites is because they are meeting my investment objectives. They have appreciated in price, they are holding fairly steady, even with the recent market ups and downs, and they continue to pay me dividends which I can reinvest in additional shares.

There have been times when they were priced very attractively and times when they were not. When they are priced at a value, I purchase more shares. When they are "overvalued" I don't add to my holdings. Simple and it works.

But, what can I do when there doesn't appear to be anything worth buying, from my stable of non-cyclical companies? Well, what I do is this: I expand my horizons, start looking at new companies that meet my DG strategy and then begin doing some due diligence on those companies to see if they fit into my overall goals.

Conclusion:

We have talked about strategies in the past. Mine is fairly simple and straight forward. Every once in a while I deviate a bit. How you invest is your business. I have always preached that a good strategy is to have a strategy. Throwing spaghetti against the wall and hoping some of it will stick is a recipe for a messy wall.

Source: Is It Time For Dividend Growth Investors To Be Buying Cyclicals?