By Martin Denholm
Despite the “sell in May and go away” investment adage, the stock market sauntered into the final day of May this morning holding steady after a furious spring rally. All three major indexes - the Dow Industrials, Nasdaq, and S&P 500 - are set to end the month at least around the same place they started it.
But don’t be fooled. The recessionary forces weighing on it will likely prove too much to bear, and stocks could merely be saving themselves for the next leg down this summer. Aside from that, a bear market rally of this magnitude simply isn’t sustainable over the long-term without another pullback along the way.
Over the past few weeks, we’ve prepared you for this by highlighting investment strategies that can not only protect you from this scenario, but also put money in your pocket, and allow you to invest with less money and risk upfront.
Here’s another great income-producing strategy that can help offset any downside - dividend stock investing…
Want To Buy A Dividend Stock? Look At These Four Areas First…
Investing in companies that give you money back for holding the shares can literally pay dividends.
It’s a strategy that works well in any market - but it’s particularly reassuring to have a stable source of passive income during a tough climate like this one. In addition, each dividend payment will reduce the original price you paid for the shares.
However, you must make sure you invest the right way. Keep in mind that dividend yields rise when stock prices fall, so in a market like this, it’s crucial that you don’t just chase after big numbers.
You need to dig a little bit deeper to make sure you don’t get stuck with a company that is all style, but no substance. While a fat dividend may be good PR and helps entice more investors to the stock, you need to make sure it’s solid. That means looking at its…
- Existing Cash & Cash Flow: How much cash does the company have on its books? Can it even afford to pay a dividend? While management can cut costs, the cash flow statement is harder to tweak. Take a look at this, plus its ability to generate cash flow from current operations, which it can dish to shareholders and reinvest back into the business. While short-term profits can fall, if a company has sufficient cash to protect the dividend, you’re in better shape than investing in one that doesn’t.
- Earnings Growth: While all companies endure short-term profit fluctuations, make sure a company has long-term earnings growth potential. Sometimes, if its potential is limited, it will sweeten the deal by paying more in dividends, which is not a particularly good long-term strategy - for them or you.
- Debt Level: While it’s not terrible for a company to have debt, the question is: Can the firm handle it? If the burden is too heavy, yet it’s still paying a cash dividend, it may not be sustainable for long.
- Dividend History: Does the firm have a good track record of raising its dividend - or at least holding it steady - through good times and bad?
Two Sectors To Consider For The Best Dividend-Yielders
When selecting dividend stocks in a bear market, it’s imperative to diversify away from volatile, vulnerable stocks.
For example, take the iShares Dow Jones Select Dividend Index ETF (NYSE: DVY). From trading in the mid $60s in early 2008, it got crunched when the financial crisis hit, as half its holdings were in financial shares.
And two WisdomTree ETFs recently combated the volatility in financials by removing the sector from two of its funds and renaming them - the WisdomTree Dividend Top 100 Ex-Financials (NYSE: DTN) and WisdomTree International Dividends Ex-Financials (NYSE: DOO).
Instead, look at sectors like Utilities and Consumer Staples, which traditionally churn out healthy dividends, as the companies within them generate critical repeat business, regardless of the economy. After all, everyone needs food, drink, electricity, and gas. As such, the balance sheet keeps ticking over and they’re able to withstand shocks better than others.
There are many utility-based ETFs, but take a look at the largest one - the Utilities Select SPDR (NYSE: XLU), which tracks S&P 500 utility stocks, or the Vanguard Utilites ETF (NYSE: VPU). The funds pay a dividend of 4.8% and 4.3% respectively. In addition, ETF Guide says the income received from the dividends is taxed at 15% rate, lower than regular income tax rates.
For a broader exposure to dividend-yielding companies, check out the PowerShares High-Yield Dividend Achievers ETF (NYSE: PEY), which includes companies that have increased their annual dividends over the past 10 straight years. It also has a 12% and 14% weighing in the Utilities and Consumer Goods sectors respectively.
The bottom line with dividend-yielding companies is to look for solid, stable businesses (preferably in sectors more resistant to the recession that can generate repeat business regardless) that can grow both now and in future, handing you some healthy passive income in an economy where it’s tough to get it.
Disclosure: No positions