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All dividend-paying stocks are not equal

In the tough year 2011 has been for investors, one segment of the stock market has started to garner a lot of attention. Larger companies which pay dividends have been endorsed by many recently as the key to your investment future. There is some sound basis for this conclusion, a basis we have used for many years, not just due to recent popularity.

Large, high quality U.S. corporations are, in general, financially healthier today than ever before. We could even make the case they are a better credit risk than many governments around the world. Many are using their large cash hoards to reward investors through increasing dividend payments and buy-backs of outstanding shares.

Studies of market history have shown that, over time, a significant portion of the returns offered by stock ownership come from the dividend payments, not just capital appreciation. Even more interesting is the fact that dividing the S&P 500 up into the components that pay dividends vs. the non-dividend payers reveals a large level of out-performance by the dividend payers.

Further sub-dividing the dividend paying group into those companies which raise their dividend regularly vs. those which have stagnant dividends show the companies which regularly enhance their dividend payment provide the best performance of all. This leads to an interesting decision for investors.

When reviewing potential candidates for your portfolio it’s easy to be attracted to those companies which sport the highest yields, which are often 5 percent or more. However, we have found two types of companies tend to reside in this group. The first are those which pay a high dividend yield because they are in a stagnant or mature industry and they have nothing better to do with their profits, such as to reinvest them in the business. This doesn’t have to be a bad thing, but may result in a portfolio which has a good cash flow from dividends now, but one which doesn’t grow much over time.

The other type of company in the higher yielding group can be an outright problem. It is the company whose yield has grown not because they have raised the dividend, but one which has seen its share price fall on hard times due to trouble within the business. Often in these cases the dividend is soon eliminated or reduced, and the drop in share price which created the “high yield” was actually an early warning signal of the impending trouble.

I prefer to focus on companies which have a history of increasing their dividend payment regularly, preferably every year. While these companies may not pay the highest yield at present, the increasing nature of the dividend payment may allow the yield to surpass those higher yielding companies you could buy today, but which have stagnant, non-increasing dividends. Another advantage of the rising dividend concept is that if the firm continues to increase the dividend it tends to be a sign of financial health, keeping us away from too many cases of “Oops, I bought the stock right before they reduced the dividend”.

I wish you and yours a very happy, healthy, and successful 2012!

Tom Breiter, president of Breiter Capital Management, Inc., a registered investment adviser, can be reached at (941) 778-1900 or by email at tom@breitercapital.com.

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