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Beat The Market With Dividends

 February 25, 2012 01:13 PM

By Josh Peters, CFA, via QFinance

I've had quite enough of the buy-low, sell-high circus. There are better ways of making money from stocks - strategies that don't rely on analyst upgrades, quarterly earnings estimates, celebrity CEOs, or patterns on charts.

I've gone back to key principles: Investing in stocks that pay me back in cash through large, reliable and growing dividends. I am not trying to double my money every 90 days with high-risk picks, but rather I am looking to preserve capital, earn attractive income and encourage long-run wealth accumulation.

How many of Wall Street's myths are you holding dear?

For me, investing is more than a business. It's a mission. Wall Street is not telling the truth about how stocks really work, and almost no one seems to have a vested interest in making money for clients first and themselves second.
Though I am a professional investor by trade, I'm a historian at heart. Let's reach past the media-driven, debt-fuelled bubbles of the past 20 years to examine how to really make money in stocks, starting by exploding a few myths that seem nearly universally held by investors.

Myth: Stocks are all about capital gains.
Fact: More than 90% of stock market returns are explained by dividends.
Depending on who and what you read, you've probably heard that the stock market returns 9%, 10%, or 11% a year. Do you know how many times the stock market has actually returned between 9% and 11% since 1945? Just once! (That was in 1993, in case you want to impress your friends.) In all other years, the returns on stocks were either higher or lower--sometimes a lot lower.

Yet amid all these fluctuations, dividends and dividends alone provide consistent returns. Not only does dividend income account for 36% of the total returns of the stock market over the past 65 years, but dividend growth - the increasing income you can't get from bonds or other fixed-income investments - accounts for another 53%. The pure speculative piece (and what occupies 90% of Wall Street's attention) accounts for only 11%.

Morningtar's DividendInvestor strategy seeks companies that pay solid yields - generally at least 3% and sometimes as much as 7% - but not so high that they're at risk of being slashed. But we don't stop there. We also want dividend growth that is at least equal to inflation, and the lower the yield on the stock the more growth we insist upon. This simple goal has paid off with more than 245 separate dividend increases for our portfolio recommendations since 2005 - and only 16 cuts.

Myth: A stock is worth whatever someone will pay for it.
Fact: The value of a stock comes from its future dividend payments.
I could wander off into the tall weeds of financial theory, but it's really not all that complicated. Think of it this way: You wouldn't put your hard-earned savings into a bond that paid no interest and never gave your original investment back, would you? Or invest directly in a small business that would never share its earnings? Why should the publicly-traded stock of a large corporation be any different? Unlike bonds, stocks don't pay interest, and they don't mature. An awful lot don't pay dividends, either. But those that do are providing real, tangible, spendable value to their shareholders every year. Why make investing any more complicated than it needs to be?

One of my favourite companies, one that pays dividends every month and raises its dividend four and sometimes five times a year, puts this phenomenon in high relief. Since the end of 1994, when its stock traded at $8.56, it has paid dividends totalling almost $20 a share. The dividends keep right on coming, and right on growing, even as that stock now trades for $34.

Myth: You don't need income from your investments--you can always sell shares.
Fact: Only dividends can help you avoid selling shares at the worst possible prices.
If you remember nothing else from this article, remember this: dividends, and only dividends, provide returns that are always positive and paid in cash. That much should make dividend-paying stocks and strategies worth getting to know!


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