Dividends and 4 other investing keys

By Michael Brush

Whew, what a decade! From the dot-com bust to the mortgage meltdown, the "naughties" were filled with peril.

Not all investors lost their shirts, however. Those who came through relatively unscathed did so by sticking to the basics.

After a nine-month rally, we enter the '10s almost assured of a pullback of some sort. And, of course, market disasters haven't been outlawed. So we all need to look to the key rules of investing that can protect us. Here are five.

Rule No. 1: Dividends matter -- a lot

We're all suckers for the latest investing fad. But dividends? Bor-ing. That's "income investing" for old folks' staid retirement portfolios, right? Not really. In fact, dividends are a key part of investing in stocks.

Consider the past decade: It was an absolute train wreck for investors chasing fads, from tech plays to housing stocks. All the major indexes finished the decade down big. In contrast, a "Lucky 13" portfolio of dividend plays from Investment Quality Trends was up 12.2% a year, on average, for the decade.

Here's why dividend plays do so well:

• Dividend stocks pay you when the stock prices idle. You get paid to wait, and the money adds up.
• Dividends suggest a company is solid. Companies get punished for cutting payouts, so they don't pay them unless they think they'll have the cash to back them up for years to come. "If company has paid rising dividends for 25 years, that tells us management is competent," says Investment Quality Trends' Kelley Wright, the author of "Dividends Still Don't Lie: The Truth About Investing in Blue Chip Stocks and Winning in the Stock Market." It also says a company knows how to develop the next generation of managers, a key to success.
  

  More basic rules for new investors

• Dividend yield (a company's dividend divided by its stock price) is a great measure of what a company is really worth. As a stock gets cheaper, its dividend yield increases. So picking companies sporting high dividend yields compared with the historical range for that stock means you're always buying "cheap" stocks -- a great investing strategy.

Dividends aren't a guarantee, however. Citigroup (C, news, msgs) and many other financial stocks had historically high dividends right before they crashed. And dividend yields that are too high (north of 10% to 12%) are actually a sign of trouble. If those yields are due to big drops in stock prices, the companies may either blow up or cut their dividends.

To avoid those disasters, Wright looks for a long history of rising dividends, a solid financial grade from a ratings group like Standard & Poor's and a yield that is near the high end of its historic range. One company that currently meets these criteria is Chevron (CVX, news, msgs). It has a 3.4% dividend yield, close to its highest level in the past two decades. "This historically indicates good value," Wright says.

He also likes cigarette maker Altria Group (MO, news, msgs), which has a 6.8% yield, and power company Exelon (EXC, news, msgs), with a 4.3% dividend yield.

Rule No. 2: Don't pay too much for a stock

Value investors, including Warren Buffett and John Neff, regularly beat the market by being careful not to overpay for trendy stocks. They go for unloved companies instead.

You know about Buffett, but here's a little background on Neff, another value star: During the 30-plus years he managed Vanguard Windsor Fund (VWNDX), through the mid-1990s, Neff beat the market by 3.15 percentage points a year on average, after expenses.

If that doesn't seem like a lot, consider that $10,000 invested in the Windsor fund in the early 1960s, when Neff took over, had turned into $564,000 by the time he left. Compare that with $233,000 for an investment in the S&P 500 Index ($INX). Those numbers come from the book "John Neff on Investing," a very readable primer on value investing that offers some simple rules of thumb.

Neff relied on a basic investing tool called the price-earnings ratio. You calculate this by dividing a company's annual earnings by its stock price. Neff stuck with stocks that traded for 40% to 60% of the market's P/E ratio.

Neff has retired, but an investment company called Validea has programmed computers to pick stocks like investing greats, including Neff, with good success. The three most recent additions to its Neff portfolio are the teen clothing retailer Aeropostale (ARO, news, msgs), convenience store operator Casey's General Stores (CASY, news, msgs) and DynCorp International (DCP, news, msgs), which provides logistical and security support to the U.S. military and government agencies. They were all added on the day before Christmas and still trade around the same level.

Continued: Don't put all your eggs in one basket

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