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Two Pieces of Advice for Dividend Investors in 2012

Back in 2009, I launched a research service to capitalize on the historic opportunities I believed existed in blue-chip, dividend-paying stocks.

Never in my career had such high-quality income investments traded so cheaply. It was as if the market was dangling single dollar bills in front of our faces, just begging us to grab them.

The only problem? Nobody cared. With stocks rallying so sharply off of the March 2009 lows, investors wanted one hundred dollar bills. They couldn’t be bothered with boring old dividend payers.

Boy, what a difference two years makes.

Worn out after months and months of volatility – and depressed by the still paltry yields offered by U.S. Treasuries and money market funds – investors are flocking to the safety and above-average income offered by blue-chip dividend stocks.

How can I be so sure? For one thing, internet searches for keywords like “dividend stocks” and “income investments” are on the rise in recent months.

Then there’s the fact that the most popular article ever on Wall Street Daily is “The Best Dividend Stocks for 2012.” Despite being written nearly a month ago, it’s received almost three times as many page views as the next most popular article.

Last but not least, there’s the tale of tape. The best-performing stocks in the last year were – you guessed it – dividend stocks.

A decile analysis by Bespoke Investment Group found that the stocks with the highest dividend yields rallied 10.42% in 2011. And a study by Birinyi Associates found that the 100 stocks in the S&P 500 with the highest dividend yields gained 8.2%.

Keep in mind, those figures are before including dividend payments, so we can inflate them by two or three percentage points. And then we’ll have an apples-to-apples comparison with the S&P 500 Index, which only rose 2% last year.

Here’s the rub: If you’re among the investors suddenly eager (and searching) for reliable income investments right now, you need to proceed with caution!

Don’t Run Blindly for Cover into Dividend Stocks

“The dividend story is good and should continue to be good,” says Standard & Poor’s Senior Index Analyst, Howard Silverblatt. I agree wholeheartedly.

Although corporate profits rebounded to record levels last year, dividend payments did not. They’re still well below historical norms. The dividend payout ratio for the S&P 500 currently rests at about 30%, compared to the long-term average of 50%, according to Silverblatt.

Add in the record amount of cash on corporate balance sheets, and not only can companies afford to keep paying dividends, they can afford to keep increasing them.

That being said, we’re not living in 2009 anymore. Valuations aren’t severely depressed, so we can’t expect all dividend stocks to keep rising in price. Only the most fundamentally solid ones hold such promise, which means we need to invest accordingly.

Specifically, we need to:

~ Be Disciplined.

Take the time to do your homework. Forget about investing in the highest yielding stocks. That’s an easy way to get snared in the dividend yield trap. Instead, insist on investing in only the highest quality dividend stocks. What qualifies as high quality? Any company that meets the seven criteria I spelled out for you .

~ Be An Investor, Not a Trader.

Yes, there’s a difference. The allure of dividend stocks is the steady stream of income they provide. And, as I’ve shown before, dividends account for a whopping 90% of total returns. However, to reap such rewards we need to invest for the long haul. (If we select properly – i.e., buy only the highest quality companies that have a history of raising their dividends each year – we might never have to sell shares.) So if you don’t plan to own a dividend stock for at least a year, don’t bother.

Bottom line: The jig isn’t up just yet for dividend stocks. But with more and more investors on the hunt for reliable income, we need to be more and more selective.

Ahead of the tape,

Louis Basenese