Talk of dividends is everywhere lately. On Fool.com alone you can see plenty of evidence of that. Last week, Dan Caplinger gave us "5 Dividend Stocks You Shouldn't Go Without," Jeremy Phillips told us about his favorite dividend stock, and Tim Beyers and Ilan Moscovitz explained why Berkshire Hathaway (NYSE: BRK-B ) is the most unlikely dividend play.
But why are investors suddenly so fixated on dividends? A week ago, I took a look at what economist Gary Shilling had to say about the economy and the investment landscape. It wasn't pretty, but I think he has a pretty good handle on why many investors are turning to dividends -- namely, they are concerned that capital gains will be hard to come by in the years ahead, and they believe they'll have to count on dividends for most of their returns.
More generally, though, I think investors have had the fear of God put in them by the recent crash, and after seeing their accounts decimated and valuations go haywire, they like the idea of tangible returns. And dividend payments that roll in every quarter are nothing if they're not tangible.
But it won't last
As a broad group, investors are a fickle bunch that tend to jump on the latest trend faster than you can say "Justin Bieber." At the end of the millennium, you had to own tech. Then, when the tech bubble was bursting, finance and homebuilders were where it was at. We had a spike in oil toward the tail end of the housing debacle, and you were crazy not to own energy stocks because we'd reached peak oil and no price for oil was too high.
Now, today, the world is a changed place, a bleaker place, and dividends are now the investment must-have.
At some point, though, probably in the not all too distant future, that'll change again. Natural resources and metals stocks already have significant momentum as do emerging-market stocks -- especially in the BRIC countries -- so maybe one of those groups will soon be all anyone wants to hear about. Or perhaps the Fed's stimulus will have the intended effect of jacking up growth, and suddenly everyone's mouths will be watering over high-growth stocks. Or perhaps it'll be something that's only peripherally on the radar right now, like nanotechnology.
But the point is, dividends will be once again forgotten like, um, Justin Bieber (just wait a few years, people; "cute" doesn't last).
The dividend crash course
Personally, I think dividend-paying stocks should always be (at least) a core piece of investors' portfolios. A solid history of dividend payment says a lot about a business and the management team that runs it. Plus, dividends account for roughly 40% of the stock market's returns, so if you miss out on dividends, you put yourself at an immediate disadvantage.
Now let's assume you are getting interested in dividends right now. Maybe you'll find the true joy of a company that pays you and end up making dividends a central part of your investing for the rest of your life. Or perhaps you'll end up getting really excited about dividends for a few years and then realize that nanotech stocks are where the real money is at. Either way, what you need is a way to dive into dividends right now without putting your portfolio in hot water.
With that in mind, here's my three-step dividend crash course.
1. High yields aren't always good yields
I've said it myself -- high-yield stocks can be very solid performers. However, the temptation for many new dividend investors is to head straight for the companies with the very highest yields. Right now that means companies such as American Capital Agency (Nasdaq: AGNC ) , Chimera Investment (NYSE: CIM ) , Invesco Mortgage Capital, and Annaly Capital (NYSE: NLY ) , which all have yields north of 15%.
But while Annaly has been around for a bit more than a decade and is a favorite of many of my fellow Fools, what most of these companies have in hefty dividends, they lack in any sort of real track record. All of these companies invest in mortgage paper of some sort, a business which has become extremely popular lately because of the low-rate environment. But with the exception of Annaly, most of these companies have histories no longer than our friend Mr. Bieber's career.
There are good high-yield opportunities, but there's nothing wrong with sticking to more moderate, but reliable, yields for the bulk of your portfolio.
2. An affordable payout
Ideally, you want a company that can afford to pay its dividend -- and, even better, grow it -- year in and year out. It's easier for a company to do that when its dividend payouts don't overwhelm its cash flow. A good picture of a less-than-ideal situation is Nordic American Tanker (NYSE: NAT ) , where there's very little cash flow available to pay the dividend, so the company makes it a practice to issue loads of new shares every year. That means the dividend is only as sustainable as the market's appetite for an endless dilution treadmill.
There are examples to the contrary. Dividend dynamo Altria (NYSE: MO ) , for example, has a dividend that sucks up just about all of the company's cash flow. But to be a high-percentage batter in the world of dividends, you'll generally be better off looking for companies whose cash flow covers dividend payments multiple times over.
Yes, it sounds like dull, hackneyed investing wisdom, but investors don't have to look to ancient history to find good reason to diversify where they're getting their payouts. Prior to the financial crisis, banks were considered a staple of the dividend universe. But for investors who decided to concentrate their portfolio on banking stocks, the results have likely been disastrous. Not only have the prices of many banks fallen, but a great many, including Bank of America and Citigroup (NYSE: C ) , are either no longer paying a dividend or have a laughably low payout.
From boring old utilities to retail and tech, you can find dividends pretty much everywhere, so there's no reason to have your entire portfolio hinging on one industry.
With any luck, I'll be proved wrong and investors will hang onto their newfound love of dividends. But even if that doesn't happen, the three points above can help you make sure only worthwhile dividend stocks are making their way into your portfolio for as long as the love affair lasts.
Want some ideas on what dividend stocks you should invest in? My fellow Fools have put together a free report with their favorite 13 dividend payers.