Stocks That Let You Sleep at Night

By Todd Wenning | More Articles
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This market is a mess, isn't it?

I hesitate to open The Wall Street Journal in the morning -- 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 Sun Microsystems (Nasdaq: JAVA  ) or Advanced Micro Devices (NYSE: AMD  ) . 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 Carnival (NYSE: CCL  ) and Hartford Financial (NYSE: HIG  ) 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 then. 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 chief financial officer, 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 69% 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 Annualized Dividend Growth	Dividend Payout as % of Free Cash Flow
The Home Depot (NYSE: HD  )	3.8%	29.2%	42%
3M (NYSE: MMM  )	3.1%	8.8%	46%
United Technologies (NYSE: UTX  )	2.8%	20%	24%

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

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. So even as the market bounces up and down in the short term, you can sleep a bit easier at night with these long-term stalwarts in your portfolio.

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.

This article was originally published on July 18, 2008. It has been updated.

Todd Wenning wondered why people stopped wearing nightcaps to bed, but was inundated with reader explanations when this article first ran. Todd owns shares of Home Depot. 3M and Home Depot are Motley Fool Inside Value selections. The Fool's disclosure policy never sleeps.