A fallen angel stock is a share of a company that is generally considered well run but that, for some reason, has experienced a material stock price decline. That's the fishing pond I like to be in since such stocks often offer historically high yields.
But there's a drawback to buying fallen angels. You generally have to suffer through middling stock performance until the company gets its wings back. I don't see that as a problem, however; I think it's a bonus. Here's why you shouldn't get upset when reliable dividend stocks stumble.
There's no way to consistently time the market
As the old saying goes, there are no crystal balls on Wall Street. While this is meant to mean you can't predict the future, it also suggests that you will be hard-pressed to time your stock purchases in any meaningful way.
The best you can hope for is to be "about right," on average. If you try to be exactly right every time, constricting your investment approach, you'll likely miss out on a lot of great opportunities. And if you shoot too widely, you might as well just buy an S&P 500 index fund and be done with it.
Image source: Getty Images.
You need a middle-ground investment approach that makes logical sense to you. Mine is to buy companies with long histories of annual dividend increases (think Dividend Kings) when they have historically high yields. I dig into each company's story and weed out companies where I just don't like the business for some reason. An example of a stock that I said "no" to is Altria Group, as the consumer staples company faces steadily deteriorating cigarette volumes.
An example of a stock I was happy to buy, on the other hand, was International Business Machines (IBM 1.38%). When I bought the stock in 2016 it had decades of annual dividend increases behind it and was struggling to transition its business to a new model. It was fairly ugly for a few years, with the business only recently starting to show material life. The big reason why I was willing to buy it was that IBM has successfully transitioned its business multiple times in the past. Now, it turns out the company has done it again.
But check out the graph above. Shortly after I bought the stock it moved sharply higher, which made me feel like a rock star! And then it started heading lower. Warren Buffett, who owned it when I added it to my portfolio, said he made a mistake and sold his stake. I seriously questioned my investment decision, but the story hadn't changed at all so I stuck with it. I basically ended up sitting with a range-bound stock until 2023, when the company overhaul started to show results.
Notice in the chart above, however, that despite the uncertainty, IBM's dividend continued to grow. And, perhaps more importantly, the technology giant continued to generate more than enough cash flow to keep paying its dividends.
IBM provided me with a huge dividend benefit
Here's the key to this puzzle: I reinvest my dividends. So for the years I ended up watching IBM do very little for my overall returns, I was adding more shares at what were mostly attractive prices. Indeed, the stock price was often around what I paid initially, and sometimes lower. The yield, which is one of the things that attracted me to IBM in the first place, remained elevated throughout the period. But since nothing changed about the story there was no reason to sell.
But those additional purchases added to my return when the company's turnaround efforts started to bear fruit. I was, effectively, leveraged to the eventual rebound in IBM's shares. I could tell the very same story about Procter & Gamble, Nucor, and Eaton, among others. I bought at about the right time, sat on what looked like dead money, allowed automatic dividend reinvestment to buy more shares at what were still attractive prices, and then was leveraged to the upturn as the fallen angels regained their wings.
To be fair, all of the stocks noted so far could fall again. But all of them also remain well-run companies and I wouldn't sell them (unless something fundamental and material changed). I'd look at a renewed drop in the stock prices of IBM, P&G, Nucor, and Eaton as a chance to buy more of great companies at increasingly attractive prices.
You can leverage yourself to the upside, too
There are plenty of opportunities for investors to buy similar stories today. I'm sitting on "dead money" in Hormel, Medtronic, and Texas Instruments. All three have hinted at or actually shown signs of improvement in their businesses, so you might want to do some research now if you are interested in reliable dividend stocks with historically high yields. Go in knowing that it could take years before the market fully appreciates the improved outlooks. But if you reinvest your dividends while you wait, you'll end up owning more shares when the stocks finally start heading higher again. And that is an extra bonus, leveraging you to the stock's recovery.
