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Today we're going to review a financial topic that
absolutely baffles 99.9% of investors.
It's not complicated or esoteric. But it's still a bit of
investing minutia that people tend to overlook or just get
wrong.
Mastering this snippet of Wall Street mathematics can change
the way you invest. It will show you how to lock in
double-digit yields you ordinarily wouldn't be able to
obtain. It's not a complicated scheme. It's perfectly
legit. It's just simple math.
Here it is:
A stock's yield is calculated by dividing the per-share
dividend by the purchase price, not the market price.
Price
and yield move in opposite directions. As stock prices rise,
dividend yields go down. As stock prices fall, dividend
yields rise.
Let's look at an example: A fictitious stock trades for $100
a share and pays a $5 dividend. You don't even need a
calculator to determine its yield: It's 5%.
Conventional thinking is that if the price of this mythical company rises, say to $200,
then its dividend yield will fall. And indeed it will
-- it will be cut in half.
$5 / $200 = 2.5%. But that only
applies to investors who bought the shares at the new price.
The investor who bought at $100 is still earning a 5%
yield.
But here's where things get interesting -- and
profitable. If the share
price moves in the other direction, down, and it drops to $50, then
the dividend yield will rise: $5 / $50 =
10%.
Once again, though, that's only true for the investors who
bought their shares for $50. The investors who bought at $100
are still earning their 5%. For most investors, yields do not
"change," they're only "established." And their stocks
keep paying that yield unless the company's actual dividend
payout changes.
Yield has nothing to do with the current
market price -- only the current dividend, and the
price you paid for your shares. If you
bought your shares at $100, a $5 dividend earns you 5% no
matter what happens to the share price, again assuming the
dividend remains constant.
That's why a bear market presents an immediate opportunity
for investors seeking significant dividend income.
Most stocks are deep into the red: Here at home the S&P 500
Index is down -20% for the past 12 months, with most world
indexes similarly in the red. Stocks in
China are off -64.9%. These depressed
prices mean dramatically higher yields. When a market falls
-50%, its dividend yields double.
And here's the kicker: When you buy a stock with a
depressed price and a high yield, you lock in that outsized
return,
just as if you'd put your money into a CD and locked in
the interest rate.
Remember: Buying a stock just for the dividend alone is a
bad idea. Dividends are never guaranteed. And a
high yield isn't always a good thing -- some of these
companies could be worthless tomorrow, like Freddie.
You want the same traits in a dividend payer as you would in
any other company you're considering: A solid financial
footing and a strong history of rising profits and dividend
increases.
To
that end, we screened for U.S. companies. We narrowed the
list to 2,890 companies, then axed every company paying less
than 7%. That winnowed the list to 44.
These 44 companies are paying an average 17.7% yield.
No
serious income investor should wait to lock in such rich
income streams. You can't afford to sit on the
sidelines. Bear-market buying opportunities just don't come
around very often. Most of the time, of course, that's a
good thing. But since a down market is already here,
you might as well profit from it by locking in these
extraordinarily high yields.
You see, no company -- or very, very few -- set out to pay a
17.7% yield. That's a tremendous yield no matter where
you go. In this country, a 5% dividend stream is above
average, even robust. But in a down market, even a 5%
yield can rise dramatically, purely because stock prices are
falling. That's the power of the dividend yield formula.
Take a look at our table. It shows what various price
drops would do to the dividend yield of a stock that
normally paid out 5%. The lower the price falls, the higher
the yield goes.
Now, if a -40% price drops
seems unrealistic, consider: Of the 30,000 equities
that trade on U.S. exchanges, 4,000 of them are down
more than -40% so far this year.
Keep in mind, also, that companies with share-price
performance like this are very, very reluctant to reduce
their dividend payouts. Wall Street usually interprets
dividend cuts as a sign of serious trouble, and executives
don't want to give investors any additional reasons to sell
stock and further damage its share price.
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Price Change |
New Yield |
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-10% |
5.6% |
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-20% |
6.3% |
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-30% |
7.1% |
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-40% |
8.3% |
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-50% |
10.0% |
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-60% |
12.5% |
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Adding in Capital Appreciation
But as strong as those rich yields are, the dividend is only
half of the potential return picture for these stocks.
We often talk about the huge returns possible by combining
"growth" and "income" strategies by investing in
international markets. It's remarkable how far a
fast-growing economy can propel a nation's equity markets.
But today, we're going to combine income with a "value"
approach.
Value investors look for otherwise stable, industry leading
companies with depressed share prices that are out of favor
on Wall Street. They buy cheap and sell dear, as one
famous such operator eloquently explained.
Our list of 44 stocks has already fallen an average -20.9%
for the year. This discount is a significant value
opportunity. The one-two payoff is a massive
double-digit dividend stream AND an average +26.4% capital
gain when the market rights itself.
And that's going to happen. It always does. You need look no
further than the history books: In 1966, the S&P
returned -11.7%. But it jumped +30.9% the next year.
In 1981, the market lost -5.1%. In 1982, it gained +21.1%,
followed by a rise of +22.4% the year after. In 2002,
the market ended a three-year losing streak with a total
decline for the year of -22.1%. But in 2003, the bulls
roared back into town, pushing prices up +28.7% in 2003 and
+10.9% in 2004.
You can choose to let current market losses erode your
portfolio or force you from the market -- or you can decide
to leverage these declines to your benefit. Entering the
market at these reduced prices and capturing these high
dividend yields is a powerful strategy for huge profits.
When "Income" Meets "Value" in the Real-World
This isn't just an academic exercise. Let's look at a real
company. One of the largest in the nation, as a matter of
fact.
On Oct. 11 of last year, these shares were trading for
$52.96. The shares were paying a $0.64 quarterly dividend,
or $2.56 a year. Investors who bought them that day locked
in a 4.8% dividend -- a decent payout, nearly twice the
average for an S&P 500 company.
Then came the subprime mess and the resultant economic
slowdown. The stock was recently trading at $33, a drop of
-37.7%. For the investor who bought on Oct. 11 -- the
shares' 52-week high -- the yield is still 4.8%. (The
dividend hasn't changed.)
But you'd earn 7.8% if you were to buy those
shares today.
And what happens if the price goes back up to $52.96? You'll
still be earning a steady 7.8% dividend stream -- and you'd
have a capital gain of some 70% on your hands. In fact, you'll
earn that same 7.8% until this company raises its dividend.
And then your yield rises.
This company is obviously very good at increasing its
revenue. The "top line" grew +70.7% from
2003 to 2007. Profits rose nearly +40%. But
dividends? They rose +153.7%. In fact, this
company's commitment to its shareholders was such that even
in 2007, when revenue fell -8.3% and profit -29.1%, the
dividend still rose +11.2%. This company has increased its payout 10 times in the
past 10 years.
This American company is not alone. It has dozens of
international peers that present similar opportunities -- a
depressed share price and a high yield.
Here are three
that we've
uncovered:
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 An Australian company that sells natural gas to customers in
South Australia, Queensland and the Northern Territory. It
had AUS$331 million in revenue last year and paid $81
million in dividends. On Jan. 1, 2007, shares were selling
for AUS$1.145 and paying a $0.10 dividend, for a
yield of 8.7%. Today, shares are selling for $0.69
-- and are still paying the dime dividend for the
year. As the price fell nearly -40%, the dividend
yield nearly doubled, to 14.5%
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A British telecommunications
firm that provides phone
service throughout the United Kingdom. The company has paid
$3 billion in dividends in the past three years, and has
increased its total payout by $200 million a year during
that time. Investors who bought their shares in 2007 earned
a 4.9% yield. The shares have since fallen to
$29.51, a decline of -50%, and, again, the dividend
yield has nearly doubled. It is now 9.7%.
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A Canadian company
that operates 200 funeral homes and 16 cemeteries in
rural areas has increased its net income +72.3% in
the past three years. In May, these shares were
yielding 9.1%. They've since fallen -40%, and the
yield has increased to 15,3%. Investors who bought
in May are earning 9.1% Buy now and you'll be
earning 15.3%.
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These are the sort of compelling stock picks subscribers
find each month in our premium High-Yield International
newsletter. It brings you in-depth research on
international markets and examines the broader economic
conditions around the world -- and shows you how to make
money from it. My staff combines the best financial
research with their keen investing acumen to bring
subscribers the most profitable income strategies the world
has to offer -- all in an interesting, easy-to-understand
presentation.
Oh, the first company we talked about above? It's none other
than Bank of America (NYSE: BAC). If you'd like
the names of those three other exciting companies yielding
more than 13%, that's
easy, too.
Just take the next step
and read more about them now.
--
Nick Lanyi
Co-Editor
Global Dividend Opportunities
GlobalDividends.com
839-K Quince Orchard Blvd.
Gaithersburg, MD 20878-1614
P.S.
-- Don't miss a single issue! Add our address, Editors@GlobalDividends.com,
to your Address Book or Safe List. For instructions, go
here.
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