In shaky times, dig deep for dividends

By Harry Domash

Tired of watching your growth stocks crash and burn in this turbulent market? If so, this may be a good time to consider high-dividend-paying stocks.

If you pick the right stocks, these dividend payers have significant advantages in a weak market. Say your share price goes nowhere for a few months. You still come out OK, because you're collecting the dividend. Also, if a market downdraft takes the share price down, the dividend yield to new investors rises, attracting more buyers.

The basics

Dividends are cash payments paid to shareholders, usually every three months. Dividend yield is your expected return on investment from dividends. It's the next 12 months' expected per-share dividend divided by the current share price. For example, the yield would be 10% for a stock currently trading at $50 per share that is expected to pay $5 in dividends over the next year.

One caveat, though: The dividend yield you see quoted on MSN Money and most other financial sites assumes that the most recently declared dividend will continue unchanged over the next year. For instance, if a company declared a 25-cent-per-share quarterly dividend, it's assumed that it will pay out $1 per share over the next 12 months. However, often that doesn't happen. Many companies adjust their payouts up or down during the year.

You'll do best by picking stocks that increase their payouts while you own them. When that happens, your dividend yield increases and the dividend increase often drives the share price higher. Conversely, a dividend cut hurts you two ways: Your yield drops, and the dividend cut usually pressures the share price.

Here's a screen for finding high-dividend candidates with good prospects for increasing their payouts. I'll start by pinpointing high-dividend payers.

Getting investors' attention

To qualify, the dividend yield must be significant enough to provide downside protection in a weak market. The definition of significant, of course, is in the eye of the beholder. However, I've found that, depending on the type of company, yields above 4% or so get investors' attention. So, I set my minimum acceptable yield at 4.25%. Since I picked the figure arbitrarily, adjust it up or down to suit your needs.

Screening parameter: Current Dividend Yield >= 4.25

Validate the yields

Sometimes, when you screen based on dividends, you'll find stocks listed with erroneously high yields based on one-time payouts, dividends that have been discontinued, or other database errors.

The screener's "latest dividend rate" parameter checks the expected next 12 months' dividends based on the most recent declared payout. For instance, the rate would be $1 if a company's last payout was 25 cents and it pays quarterly.

By trial and error, I've found that you can reduce the number of false hits by requiring a positive value for "latest dividend rate."

Screening parameter: Latest Dividend Rate >= 0.25

Keep risk at bay

Minimizing risk is essential ingredient for successful dividend investing. Fortunately, doing that isn't rocket science.

For instance, a stock's trading price tells you a lot about how other investors view its fundamental outlook. Cheap stocks get that way because most players see problems ahead. So you can reduce your risk by avoiding such stocks. What's too cheap? Many institutional investors avoid stocks trading below $15 and I used that for my minimum. Try reducing the cutoff down to $10 if you don't mind the extra risk and want to see more stocks.

Screening parameter: Last Price >= 15

Check fundamentals with StockScouter

MSN's StockScouter evaluates stocks based on factors such as valuation, insider ownership and much more. Its fundamental grade ranks a stock from A to F based on a variety of considerations involving analysts' earnings forecasts. For instance, stocks where analysts have recently increased earnings-growth forecasts rank higher than those with downtrending forecasts.

While high-dividend payers aren't usually fast earnings growers, a low fundamental grade means that analysts see deteriorating growth, which could translate to dividend cuts down the road.

I require a minimum C grade, which should be enough to weed out stocks with weakening fundamentals.

Screening parameter: Fundamental Grade >= C

Bigger is better

When the market turns down, investors typically dump their smaller stocks in favor of large companies, an action often described as a "flight to quality." Thus, to minimize risk, it pays to avoid very small stocks.

Market capitalization, which is how much you'd have to pay to buy all of a company's shares, is the most widely used size gauge. I required a minimum $1 billion market cap, which rules out small caps, the riskiest category. Consider raising that limit to $5 billion or so if you want to further reduce your risk.

Continued: 12 top stocks that pay dividends

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