Of late, it certainly hasn't been the best of times for young investors to try to learn to invest. The chance for rising interest rates, sky high oil prices, the upcoming Presidential election, and the war in Iraq have certainly lead to rocky times in the market throughout the first quarter of 2004. Especially at the beginning of the year, solid earnings figures were being overshadowed by uncertainty about these events. In fact, one of the anchors on CNBC referred to today's market as the "I.O.U. market: interest rates, oil and uncertainty." As we all know, uncertainty means risk, but the fact that some stocks have fallen despite strong first quarter results has lead to some great buying opportunities. In fact some analysts are now thinking the indexes could see a 10% rise from here.
Still not confident enough? Well, there is one long forgotten way to help make a profit without too much downside risk: dividend yield. During the dot com boom of the 1990's, dividends were looked down upon because paying a dividend meant the company wasn't using that cash for future growth. During this time, dividend yields on stocks in the S&P 500 dropped considerably. A growth company declaring a dividend at the time was almost taboo. In fact, Microsoft, which has more cash on hand than any other company in the world, never paid a dividend until their eight-cent dividend last year.
In today's markets where it takes more than a dartboard and a copy of the WSJ to beat the markets, companies with high dividend yields are becoming more attractive investments for several reasons. First, President Bush's plan that cut taxes on dividends effectively increased their return. Second, since total return on a stock is comprised of dividends and appreciation of the stock's value, it makes sense that if a company can pay a dividend without hurting its growth, it will have a higher return. Also, it shows that management is attentive to keeping investors happy as well as maintaining strong cash flows if they can find a way to consistently increase their dividend. This strong management could in turn help lead to the appreciation of the stock's price. In fact, research by Eugene Fama and Kenneth French has shown that since 1926, stocks in the S&P 500 with an above average dividend yield have typically had above average total returns. Thirdly, dividend yields historically rise as interest rates are set to rise. While this by no means implies simply investing in any stock with a high dividend yield will be a good investment, it is something to consider. Either way, you should thoroughly research a stock before buying it. For example, most stocks with high dividend yields are financial companies or REIT's, which could see their price greatly depreciate in a rising interest rate environment. On the other hand, some of these fears may have already caused the firm's stock price to go down since Greenspan warned of a "measured" increase. As I previously mentioned, this presents a good buying opportunity. One specific example is Commerce Bancorp (CBH). The stock fell from around 61 to about 55 in late April when it released its first quarter earnings. Even though its EPS of 75 cents was directly in line with analysts estimates of a 25% increase from that quarter a year earlier, the markets overreacted that they didn't beat expectations. The stock has since risen back up to 61.50. Lastly, some companies offer dividend yields that produce a higher return than bonds, and the yield grows faster than the rate of inflation, roughly 2.3%. This means that even if the price doesn't appreciate at all, you will still have made a gain in real terms.Another safe alternative in a rising interest rate environment to a high dividend yielding stock is a Treasury Inflation Protected Security (TIPS). A TIPS is very similar to any other bond issued by the Treasury. In return for some initial payment to obtain the bond, the investor receives interest payments and then gets the principal back at maturity. However, for most bonds, the price and interest rate are negatively related, which means in a rising interest rate environment, the bond's price will fall and the investor will suffer a capital loss. If he or she holds on to the bond till maturity, they don't suffer a capital loss, but their yield isn't as high in real terms. On the other hand, TIPS have the nice feature that they still pay a fixed interest rate, but their principal is pegged to the inflation rate. This protects the investor from both losses described above. While the yield on TIPS may not be as high as the dividend yield on some stocks, they are a safer investment because they perfectly hedge against inflation. Either way, TIPS and high dividend yielding stocks are two great ideas to consider in this market of interest rates and uncertainty.