- Created on Tuesday, 26 March 2013 00:00
- Published on Tuesday, 26 March 2013 07:00
- Written by Jim Nelson, Guest Editor, Inside Investing Daily
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If you are searching for stocks that yield super-high dividends, you're probably making a big mistake.
That's because high yielders are much more volatile and tend to underperform larger, safer dividend payers with longer histories of dividend payments.
The first step to building a bulletproof income portfolio is not to reach for yield into riskier stocks. It's to start with a solid foundation. To buy only the safest dividend stocks.
These stocks should make up the "bedrock" of your portfolio.
Take a look at the chart below. It shows the performance of three important indexes since the start of the 2008 crash, all reset to a baseline of 100. They are the S&P 500 (blue line), the S&P 500 Dividend Aristocrats Index (green line) and the S&P High Yield Dividend Aristocrats Index (red line).
As you can see, the Dividend Aristocrats Index wins hands down. This index contains only S&P 500 companies that have grown their dividends every year for at least 25 years.
Only 51 companies -- a hair over 10% of the entire index -- qualify. That's the kind of "bedrock" you're looking for.
The High Yield Dividend Aristocrats Index selects its constituents from the S&P Composite 1500, a larger group of stocks that includes many riskier plays. Also, it requires only 20 years of dividend increases. That's how it can find higher-yielding stocks than the Dividend Aristocrats Index.
But sticking to larger, longer-paying dividend stocks would have made you 14.4% more on your investment than if you had stretched for those high yields. And it outperformed the S&P 500 by an impressive 32%.
The reason is simple. High-yielding stocks often don't stay that way for long.
Typically, the reason they have higher-than-average yields is they carry more risk and have less growth potential than their rivals. So they bump up their dividend payments to attract investors. Other times, these higher yielders are paying out too much of their earnings through dividends and can't sustain their payout ratios.
Take beauty products maker Avon Products Inc. (NYSE:AVP), for example. Its board was recently forced to cut the company's quarterly dividend from 23 cents to just 6 cents per share. That's a massive blow to income-hungry shareholders.
This is why I recommend that readers of my income advisory service, Income & Dividend Report, start off by building a solid bedrock of income.
That means buying shares in companies that have long histories of raising their dividend payments. I also look for large-cap companies with strong earnings growth, products that their customers can't live without and strong management teams.
These companies are best placed to weather market storms. They are also best placed to continue growing their earnings -- which they must do if they are to keep paying out higher dividends.
One my favorite "bedrock" dividend payers right now is consumer products maker The Clorox Co. (NYSE:CLX), which owns household brands such Pine-Sol cleaners, Poett home-care products, Fresh Step cat litter and Glad trash bags.
Clorox has been paying a growing dividend for 35 consecutive years. And it has continued to lay the foundation for future dividend hikes by entering new, fast-growing emerging markets.
Make this -- and stocks like it -- the bedrock of your income portfolio. And don't get suckered by high yielders that can't sustain their dividend payouts.
P.S. Clorox is a great way to start building a bulletproof income portfolio. But there are even more solid and safe dividend stocks out there. I recently recommended two of these super-safe stocks to Income & Dividend Report readers. To find out how to get access to them and to start receiving future recommendations, follow this link.
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