Wednesday, September 22, 2010

How to make money in dividend stocks despite WallStreet

Over the past years volumes on US stock exchanges have consistently reached record levels, which were unimaginable only a few years ago. The mass electronization of markets and the death of the trading floor, has provided accessibility to anyone in the world to trade US stocks on their computer. With the decrease in commissions and bid/ask spreads, investing in stocks has never been more appealing. Because of the ease of trading electronically, a large portion of the volume these days is being generated by super computer programs, which have been set up to squeeze in tenths of a cent from exchanges in liquidity rebates and spread running hundreds of times per day. The flash crash of 2:45 on May 6, 2010 showed investors that super computers pretty much rule the market these days. As a result, it may seem that only big investment banks such as Goldman Sachs (GS) which could afford to invest millions in sophisticated trading algorithms have any edge in the market.

This statement is partially correct, but only to the extent that one is trading with a short term horizon. There still seem to be pockets of opportunity, where the quarter end results mesmerized investment banks do not have the patience to venture out. One such pocket of opportunity entails following a strategy where investors disconnect themselves from WallStreet, and instead focus on what stands behind the stocks they are analyzing. This strategy has actually been followed by famous investor Warren Buffett throughout his investment idea. He is famous for saying “Even if they close the market for 5 or 10 years, we still make money”.

So how do investors make money in the market, even if the market is closed? The answer is very simple, but as every other simple question it is difficult to grasp because of its simplicity. The answer is to get back to the basics. Stocks are not just blips on a computer screen that you could purchase at the ask price and hope for another “fool” to unload to at a fraction of a penny higher. Stocks represent actual ownership portions in real businesses, whose products or services are being used by many consumers or businesses. Despite the fact that we live in a global economy ruled by ruthless multinationals, the basic idea is that stocks still represent ownership in real businesses. As a result, the only reason why long-term investors should purchase stock in a company is because :

1) The stock is trading at an attractive valuation. Depending on your style of investing that could be based off a P/E ratio of below 20 or a net current asset value to stock price of less than one.

2) The company behind the stock has solid competitive advantages, is run by competent management, and could achieve decent growth in earnings over time.

3) The company shares a portion of its growing profits with shareholders, by paying growing dividends.

Dividend investors are particularly well positioned for a situation where the market is closed, particularly because they are mainly interested in receiving a stable and growing stream of distributions, while seeing the business they invested in years ago keep growing. The stock market is important to dividend investors mainly to check for mispriced opportunities. While it would be unfortunate if the stock market were to remain closed for 5 to 10 years, dividend investing would still work. In fact dividend investing works in all market conditions, since it keeps providing a return on investment regardless of market conditions, as long as the business fundamentals allow it to do so. To most dividend investors a fall in stock prices is seen as an opportunity to accumulate more quality companies at bargain prices.

Investors could earn dividends with stocks such as these:

The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. The company is member of the S&P 500, Dow Jones Industrials and the S&P Dividend Aristocrats indexes. Coca-Cola has paid uninterrupted dividends on its common stock since 1893 and increased payments to common shareholders every year for 48 years. One of the largest holders of Coca-Cola stock is no other than the Oracle Warren Buffett, who is the chairman of Berkshire Hathaway (BRK.A;BRK.B) and one of the best investors in the world. Yield: %(analysis)

McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 33 consecutive years. McDonald’s is one of the world’s most recognizable brands. Because of this and because it has performed very well to stockholders over the years, it is one of the most widely held income stocks by dividend investors. Yield: % (analysis)

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates in three segments: Consumer, Pharmaceutical, and Medical Devices and Diagnostics. Johnson & Johnson is a major component of the S&P 500, Dow Industrials and the Dividend Aristocrats Indexes. One of the company’s largest shareholders includes Warren Buffett. JNJ has been consistently increasing its dividend for 48 consecutive years. Yield: % (analysis)

Medtronic, Inc. (MDT) develops, manufactures, and sells device-based medical therapies worldwide. This dividend champion has raised distributions for 33 years in a row. Yield: (analysis)

Diageo plc (DEO) engages in producing, distilling, brewing, bottling, packaging, distributing, developing, and marketing spirits, beer, and wine. The company offers a range of premium brands comprising Smirnoff vodka, Johnnie Walker scotch whiskies, Captain Morgan rum, Baileys Original Irish Cream liqueur, J&B scotch whisky, Tanqueray gin, and Guinness stout. Diageo is an international dividend achiever, which has raised distributions for over a decade. Yield: (analysis)

These stocks are just a sample of strong dividend payers, which have been able to raise distributions to their loyal shareholders for years or decades. For lists of complete dividend growth stocks, check out the dividend champions list maintained by David Fish.

Full Disclosure: Long DEO,KO, JNJ, MDT,MCD

Relevant Articles:

- Buffett the dividend investor
- Dividend Investors are getting paid for waiting
- Dividend Investing Works in All Markets
- Living off dividends in retirement

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