How to Weather Market Panics

This week's news events are, in a word, overwhelming. Trying to get your head around how iconic Wall Street names can implode is a challenge for investors of any level.

Basically, companies like Lehman, Bear Stearns, and AIG took on way too much debt and way too much risk. Now the bill has come due, and no one can pay it. As a result, assets and businesses need to be sold.

However, while Lehman burned and the market panicked, SYSCO and Abbott Laboratories investors learned that their companies had quietly declared their 155th and 339th consecutive dividend payments, respectively. Put simply, for SYSCO and Abbott, it was business as usual this week.

What this teaches us
Though this crisis is historic in its scale, major market shakeups like the one we're experiencing now occur every so often. The only thing you can do is prepare your portfolio for anything the market throws at it.

That means owning dividend-paying stocks. In addition to the comfort of receiving a steady check even as the market careens, academics Kathleen Fuller and Michael Goldstein found that dividend paying stocks outperform non-dividend payers by 1%-1.5% per month during market declines.

The key thing for you to keep in mind when building your high-yield portfolio is to select 15 to 20 companies from different industries. This reduces your income volatility because even if one sector fails, the others should continue to make their payments.

Case in point ...
If you were tempted by high yields in beaten-down financial stocks last October, you could have loaded up on companies like Washington Mutual (NYSE: WM  ) and Wachovia (NYSE: WB  ) when they were yielding 8% and 5%, respectively, hoping to wait out the storm and make a pretty penny in the process. While that may have worked out for a quarter or two, both companies have since slashed their dividend payments, which would have put your income returns (and portfolio value) in real jeopardy.

Even though stocks from other industries may not be doling out 6% or 8% yields, they still need to be part of your mix. Adding dividend payers from various industries may lower your portfolio's overall yield, but you concurrently reduce the risk of disaster while promoting income stability and growth.

What to look for
Here are a few important characteristics to look for when building your diversified dividend portfolio:

  • Larger-cap stocks,
  • With at least a five-year history of increasing dividends,
  • Moderate debt levels, and
  • Sufficient dividend coverage on a free cash flow basis

A few stocks that fit this profile include:

Company

Industry

Yield

FCF Payout Ratio

Debt-to-Equity

Procter & Gamble (NYSE: PG  )

Consumer Staples

2.2%

36%

0.53

Johnson & Johnson (NYSE: JNJ  )

Health care

2.6%

42%

0.30

3M (NYSE: MMM  )

Conglomerate

2.8%

40%

0.48

Chevron (NYSE: CVX  )

Utilities

3.1%

53%

0.08

Automatic Data Processing (NYSE: ADP  )

Technology

2.7%

34%

0.01

*Source: Capital IQ, a division of Standard and Poor's.

Foolish bottom line
This week's Lehman Brothers news is just another reminder of the importance of portfolio diversification. As we've seen time and again, making huge bets on any industry, whether it's financials, technology, or commodities is recipe for disaster.

If you'd like some help finding a broad range of the market's top dividend stocks, consider a free 30-day trial to Motley Fool Income Investor. Since 2003, Income Investor picks are outpacing the market by seven percentage points and have an average yield of 5%. To start your free trial, click here. There's no obligation to subscribe.

Todd Wenning knows the sound of one hand clapping. He owns shares of Procter & Gamble, but of no other company mentioned. Sysco and Johnson & Johnson are Motley Fool Income Investor picks. 3M is a Motley Fool Inside Value recommendation. The Fool's disclosure policy is long the U.S. of A.


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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 September 19, 2008, at 7:31 PM, bmnew wrote:

    This article is a bit dissapointing. it's reassuring for the fragile or new investor but adds little insight to the more experienced ones who subrscibe!

  • Report this Comment On September 19, 2008, at 11:32 PM, valari25 wrote:

    Todd, I just want to thank you for the effort you put into helping others learn the world of investing.

    After burning my portfolio by going heavy into tech during the bubble and staying out of the market for years, I completely switched gears and went to dividend investing. I follow your HYP and use it for myself.

    While the savvy, experienced investor may not have a need for this article it does wonders for those who are new and those like myself who are switching investing gears.

    Kudos and keep up the good work!

    Jeff

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