There is no such thing as an objectively perfect stock -- much less an objectively perfect dividend stock. While some investors seek high yields irrespective of risk, others prefer stability as the ultimate arbiter of perfection. And in between these polarities lay a dizzying array of combinations.
The main challenge for you as an investor is to identify where on this continuum you fall. Do you love risk, hate risk, or are you neutral insofar as risk is concerned? Your answer to this question will then naturally inform your approach to finding the subjectively perfect stock for your portfolio -- of which there are many good candidates, as you'll see below.
The significance of yield
By now you've probably heard about the bond yields of European government debt. On the one hand, you have Germany's 10-year bond yielding just over 2%. And on the other, you have Greece's at around 32%. As an investor, isn't it obvious that one would prefer Greece's bonds over Germany's? Why settle for a measly 2% when your money could just as easily produce 16 times as much income?
This is a trick question, of course, for we all know that the likelihood of Greece repaying its debts in full is slim to none -- and even that characterization leaves more hope than is probably warranted. The point is that yield communicates risk. It's as simple as that. The higher the yield, the riskier the investment. The lower the yield, the safer.
And what's true for government bonds is true for dividend stocks. Thus, anytime you come across a stock with a double-digit yield, think about Greece before unwittingly taking a plunge.
Yield doesn't exist in a vacuum
While knowing that yield communicates risk is vital, it's nevertheless only half the battle, as risk is a relative concept. Put another way, we only know that Greece's bonds are risky because they yield 30 percentage points more than Germany's.
The trick is to identify benchmarks you can use to gauge a specific stock's relative yield. I prefer to use the yield of the S&P 500
The table below provides a sampling of popular dividend stocks and how they compare to this average.
Annaly Capital Management
Procter & Gamble
Sources: The Wall Street Journal's Market Data Center and Yahoo! Finance.
Which of these things are not like the others?
Most stocks cluster around the S&P 500's average. Even among these above-average yielders, Procter & Gamble yields just a single percentage point more. Verizon, on the other hand, yields twice as much, communicating a higher degree of risk that's probably associated with the commoditized nature of its industry.
The outliers in the crowd are obviously Annaly Capital Management and Chimera Investment, well-known mortgage real estate investment trusts. And suffice it to say, as I've discussed previously, there's a reason for that -- namely, their unique sensitivity to interest rate fluctuations. That's not to say, of course, that one of these high-yielding stocks isn't the perfect dividend stock for you. But my point is that they'd only be perfect for someone who's ready and willing to assume the high risk of owning them.
Finding the perfect stock for you
At the end of the day, regardless of your risk tolerance, every investor needs a place to start their search for the perfect dividend stock. So where should you begin? While there are a number of institutions that charge for this type of advice, my recommendation is that you start with a free report that our top-rated analysts recently published profiling 11 rock-solid dividend stocks, any one of which could singlehandedly form the core of an extremely profitable portfolio.
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