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How to Pick Top Dividend Stocks

Written By Brian Hicks

Posted September 17, 2009

Whether you are young, old, or consider yourself somewhere comfortably in between, top dividend stocks have a place in every investor’s portfolio — especially if you’re serious about investing for retirement.

Because as we discussed last week, if you’re counting on the retirement fairy to keep you from spending your golden years as a Wal-Mart greeter. . . you are in for a rude awakening.

After all, Social Security seems as rock solid as a bowl of Jell-o these days. Thus, how you spend your retirement years depends entirely on you. 

The good news is that dividend-paying stocks can help you make the transition without keeping you awake at night, staring at the ceiling. . .

And here’s the why and how: Even in bear markets, top-paying dividend stocks typically do well, especially if the companies have a strong history of increasing the dividend payout.

That’s because investors win two-fold when a company increases its dividend. First, the yield on your initial investment goes up with the dividend; and second, the dividend increasing itself often propels the share price higher — even better!

That’s why long-term investors are so eager to gobble up high dividend yields these days. It is an unbeatable combination in today’s tough markets

So What is Dividend Yield?

Dividend yield is simply your rate of return from the dividend payouts, exclusive of any stock price appreciation. It’s calculated by dividing the dividends you receive over a year’s time by the price you paid for the stock.

For example, your dividend yield is 5% if you paid $20 per share, and you receive $1 per share in dividends ($1/$20) over the 12 months following your purchase.

Dividend yield, however, is not a fixed number; it changes along with the share price.

For instance, say someone else buys the same stock a week later, when the share price had moved up to $25. Instead of 5%, their dividend yield would only be 4% ($1/$25).

In short, it is a cash payout that you receive for simply being a shareholder, sort of like receiving a bonus based on the company’s earnings.  Moreover, these “bonuses” also offer lower tax rates than similar investments in savings, CDs, or money market accounts offer.

And once you receive your dividend payout, there are only two rules to live by if you’re serious about building a nest egg you can depend on:

1. Reinvest your dividends — When an investor receives dividends, they have two choices. The first choice is to spend it. The second choice is to immediately take those funds and purchase more stock. The smart investor chooses the latter. Dividend reinvestment programs, commonly known as DRIPs, are an automatic way to build wealth over time.

2. Remember the Rule of 72 — Compounding is one of the most powerful forces known to man. That’s where the Rule of 72 comes in. The rule says that in order to find the number of years it takes to you double your investment at a given rate, you just divide the yield into 72.  For example, if your are earning a 9% on your investment, it only takes eight years to double your money. . . and roughly 13 years to triple it.

Smart dividend investors know that it’s the tortoise — not the hare — that wins this race.

How to Pick Top Dividend Stocks

Picking successful dividend-paying stocks, however, is not as simple as buying only the stocks with the highest dividend yield. In fact, the stocks with the highest yields often trip up investors the most.

Picking winning dividend stocks usually requires finding candidates with the following qualities:

  • The payout should have strong history with a minimal risk of a dividend cut.
  • There should be a high probability that the dividends will increase while you own the stock.

Those two factors are exactly what make dividend-paying health care stocks so attractive these days.

Because let’s face it, 78 million baby boomers aren’t getting any younger. That will undoubtedly provide a steady stream of revenue for the industry at much higher costs.

In fact, it is estimated that health care spending will cost an estimated $13,101 per person by 2017. . . compared to today’s average cost of $7,026 per person.

Multiply that figure by the wave of boomers soon to need more care and you have the type of environment that will keep those dividends growing for many, many years to come.

Armed with that surefire scenario, here are two names in the health care sector that will help give your portfolio the boost it needs to take care of you later in life:

  • Johnson & Johnson (NYSE: JNJ) — Sure, this a “widows and orphans” pick all the way — but don’t let that stop you. This is one great company with dividend history that is as solid as it gets, including some 47 consecutive years of dividend growth. The current yield is a solid 3.20%. By the way — Warren Buffet is among its biggest shareholders.
  • Omega Healthcare Investors Inc. (NYSE: OHI) — On the higher end of the yield scale, OHI is a real estate investment trust that provides financing and capital to the long-term care portion of the industry. As such, the company owns or holds mortgages on 255 facilities with 29,002 beds, operated mostly by third party health care companies. Dividend growth at the company has been solid for the last five years. The company currently trades at a 7.0% yield. The best part? They do it all with only 19 full-time employees.

So don’t let the prospect of a longer bear market or some tough retirement years keep you from achieving your financial goals. A portfolio made up of top dividend stocks is an easy road to follow.

All it takes is that crucial first step.

Your bargain-hunting analyst,

 steve sig

Steve Christ, Investment Director

The Wealth Advisory

P.S. The health care industry isn’t the only place to find top quality dividend stocks these days. One of my favorites is a chemical sector stock company with a 4.8% yield that has absolutely hit the stimulus jackpot, putting Wealth Advisory subscribers up 28% in 6 months with bigger gains to come. As for its dividend history, this winner hasn’t missed a payment in over 82 years! To learn more about this opportunity, click here.