Stocks That Let You Sleep at Night

This market is a mess, isn't it?

I hesitate to open The Wall Street Journal in the morning anymore-- I'm afraid of what I might find. On any given day, it's not out of the question to read that another bank has collapsed or another foreign company has purchased another iconic American institution.

I hope you haven't lost any sleep over this market madness, but I understand if you have -- especially if you've been on the wrong end of IndyMac, Bear Stearns, or Fannie Mae (NYSE: FNM  ) . Losing money is painful, and when you lose a lot of it, it's even worse.

To compound the problem, even dividend-paying stocks, which are often great stocks in bear markets, have been rattled this year. Some, like Wachovia (NYSE: WB  ) , General Motors (NYSE: GM  ) , and Sprint Nextel (NYSE: S  ) have even taken measures to slash or suspend their dividend payments.

We feel your pain
It's particularly discouraging when even your best stock ideas turn sour.

At our Motley Fool Income Investor service, we felt that pain with Tuesday Morning, a nationwide retailer of closeout home merchandise, which we recommended to subscribers in January 2007.

At the time, Tuesday Morning seemed to be a stock screaming "buy me!" It was 55% off its 2005 highs, and it was in the early stages of a turnaround with new but retail-seasoned management and a fresh dividend policy, which equated to a 5% yield at the time. The worst seemed to be over for the company.

Or so we thought. Fast-forward 11 months -- and we recommended a "sell" of the stock for a 53% loss.

What the heck happened?
Over those 11 months, Tuesday Morning was hit hard by the falling housing market and an all-out market attack on retailers. Perhaps we could have better anticipated that, but what we couldn't have anticipated was the abrupt resignation of the CFO, which ended up being the last straw. We folded up our tents and ate the 53% loss.

Hey, it could have been a lot worse. The stock has dropped an additional 57% since we got rid of it -- and the dividend has been eliminated altogether. But that's of little consolation. The loss still hurt.

The lesson we learned from Tuesday Morning was best summed up by advisor James Early: "We're predominantly about finding best-of-breed companies that let you sleep at night. And [the resignation of the CFO] has knocked Tuesday out of even the broadest Income Investor net."

Tuesday Morning served as a reminder of what dividend investing is all about -- building wealth steadily in great companies and not getting mired in deep-value turnaround plays, complex arbitrage situations, or any of the other daily market machinations.

Great. Now what?
To find best-of-breed dividend-paying stocks that let you sleep at night, look for those with, among other things:

  • a top market position in its sector
  • sustained history of dividend growth
  • a clear, defensible competitive advantage
  • experienced management
  • a dividend payout sufficiently below free cash flow

Companies that currently fit this bill include:

Company

Dividend Yield

5-Year Dividend Growth

Dividend Payout as % of Free Cash Flow

Procter & Gamble (NYSE: PG  )

2.5%

11.7%

32%

Johnson & Johnson (NYSE: JNJ  )

2.7%

15.1%

41%

Kimberly Clark (NYSE: KMB  )

4.2%

11.8%

66%

Source: Capital IQ.

In addition, each of these companies has a CEO with more than five years on the job and a distinguished track record of rewarding shareholders with increased dividend payouts.

In other words, you can rest a bit easier at night with stocks like these in your portfolio.

Stocks that put you to sleep?
Investing in dividend-paying stocks may sound boring, but in fact they can turn out to be the most unlikely growth stocks and -- given time -- can even help supplement your income in a major way.

If you'd like to see the dividend stocks that James and co-advisor Andy Cross are recommending to Income Investor subscribers right now, a free 30-day trial to the service is yours. Click here to get started.

Todd Wenning wonders why people don't wear nightcaps to bed anymore. He owns shares of Procter & Gamble, but of no other company mentioned. Kimberly-Clark and Johnson & Johnson are Motley Fool Income Investor recommendations. Sprint Nextel is an Inside Value selection. The Fool's disclosure policy never sleeps.


Read/Post Comments (3) | Recommend This Article (34)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 20, 2008, at 1:53 PM, tomjet wrote:

    I am surprised you even recommended this company at all. I had never heard of it until I read your post just now. Recommending a company after its stock falls more than 50% when that company is not a household name is one mistake; another mistake is not selling such a stock after it falls more than 8% to 15% from your average purchase price. Think of that 8% to 15% loss as the cost of insurance against a very substantial greater loss, which happened here. I am not writing just to criticize. I hope that what I am saying is constructive. Another point: in my view, it is always a mistake to not take into account investor psychology/sentiment and to, instead, focus narrowly on the financial numbers only (the fundamentals only). On a positive note, I agree wholeheartedly with your recommendation of P&G and, to a slightly lesser extent, JNJ.

  • Report this Comment On July 20, 2008, at 6:23 PM, Boo2007 wrote:

    Если говорить за акции FNM, то у этой компании есть хорошая опора - недвижимость с которой она работает

  • Report this Comment On July 25, 2008, at 2:46 AM, DutchMark wrote:

    At the time Tuesday Morning was recommended I was an Income Investor subscriber. I posted my concerns about this recommendation on the board shortly after that. Apart from not liking the concept as a business, it was beyond my comprehension how you could recommend a company that had little dividend-paying history and that had to go into debt to pay for it, considering the concept of the newsletter to recommend steady and reliable dividend payers.

    Of course the current weak retail environment compounded Tuesday's problems. But long before that it was obvious that the dividend had a very weak basis and it was a business on the decline. This article makes it sound as if the stock's decline was caused by circumstances that could not have been foreseen but I strongly disagree. In my opinion this recommendation was a case of poor judgement.

    This happens to the best investor at times of course. But then better admit it, it does subscribers a better service.

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