The Artful Dodger: Getting Out In Front of Changing Dividend Yields

by | Jul 1, 2015

Part 2 of the Dividend Power Series July 1 2015Artful-Dodger-1

Since early in 2015, dividend paying stocks and mutual funds have been on the defensive. The long anticipated increase in short term interest rates administered by The Federal Reserve has caused many once -bullish investors to exit certain income paying assets before The Fed increases rates; a trade that has seemingly worked out well in the short term. 

For investors who understand the value of dividends, markets are now beginning to offer the best opportunity to acquire dividends from high quality assets since late 2013. Many top notch names among electric utilities, telecom, integrated energy, pharmaceuticals and other sectors have now fallen to levels which seem quite buyable after a prolonged levitation at premium valuations. Persistent global deflation fears and repeated growth scares throughout 2013 and 2014 kept income paying assets of all sorts and dividend paying stocks and funds in particular at rather high levels which offered only marginal added value; but that is now changing. However, grabbing dividend paying assets while they’re down is not as simple as it seems, some artfulness will be necessary to insure success.

But before buying dividend paying assets, it must be understood that owning and managing a portfolio of dividend earning investments, according to the Dividend Power model, is as much an art as it is a science.

Among the key characters in Charles Dickens’ classic novel Oliver Twist was Jack Dawkins, known in the story as “The Artful Dodger”. He gained this nickname because of his skill as a pickpocket, but in the case of the dividend investor, one must be a different kind of Artful Dodger. In order to be artful in owning the right dividend paying assets, one must dodge the wrong ones.

But which are the dividend paying assets to avoid? The answer can be variable depending on price, interest rate trends and many other factors, but there is a correlation between current yields and overall long term value. The higher the current yield, the lower the implied long term value. One example may be a comparison between a strong dividend paying common stock such as VZ Verizon, which pays a straightforward dividend that can increase over time and offers the possibility of long term price appreciation, versus a leveraged closed end fund that can pay a high current dividend return but lose value over time if purchased at too high a price. Other categories of dividend paying assets that the artful dividend investor may wish to dodge are MLPs, which can pay great current returns but can lose value rapidly when the industry group (usually energy) is out of favor or interest rates are expected to climb. The same is true for REITs, which can be great if purchased when very cheap, but painful to own if bought at the wrong time and at the wrong price.

Conversely, the artful dividend investor knows when to buy leveraged closed end funds, MLPs and REITs; usually when they are very out of favor and have suffered steep declines which has most retail investors and hedge funds running away from the sector. It is here where art meets investing science; knowing and even feeling the difference in what to pay for yield-paying asset classes.

More on Dividend investing in the next installment of The Dividend Power Series.

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