Transcription

1 Zacks Investment Research, Inc. 10 S. Riverside Plaza, Suite 1600 Chicago, Illinois 60606

2 Contents Introduction 2 Section 1: The Mental Aspect 3 Section 2: Getting the Most Out of the Income Investor 6 Section 3: Follow the Leader 7 Section 4: How to Read Income Investor Alerts 8 Section 5: How to Read Income Investor Summary 9 Section 6: Virtues of Money Management 10 Section 7: Ever-present Cliché Rings True 11 1

3 Introduction The Income Investor service will be focused on stocks that benefit from both price appreciation and dividends. Our goal is to identify companies that have sound fundamentals, and return their cash to the shareholders. For this Investor Service, dividends are a crucial part of the overall strategy. And for long-term investors, dividends should be very important to you and your portfolio. To illustrate, from 1960 to 2016, 81% of the total return of the S&P 500 index is due to compounding and the reinvestment of dividends. But the service will not just be focused on the dividend yield. There are plenty of stocks out there that offer alluring yields but have poor cash flow or virtually no growth prospects. That s why the service will delve into the underlying business fundamentals along with the dividend. And that s where the Zacks Rank comes in. Our portfolio will consist of companies with both a strong dividend yield and stable to improving earnings estimates. Because rising earnings means higher cash flows and, in turn, the ability to pay out more in dividends. There are businesses out there that generate significant free cash flow and routinely distribute that cash to shareholders through higher dividends year after year. These are the companies we will focus on. It s important to note that while dividend stocks tend to be less volatile than the overall market, they are not completely immune to pullbacks. Prices can swing wildly over the short term, so a long-term approach and a strong stomach are a necessity. But over the long run, high quality, high yielding stocks can be a low risk approach to generating tremendous wealth. Welcome aboard. Brian Hamilton Editor, Zacks Income Investor 2

4 Section 1: The Mental Aspect It is important to keep your eye on the ball when investing. Dividend investing is a long-term, slow and steady approach. It s always tempting to go for the quick strike, throwing the long pass rather than grinding it out with three yards and a cloud of dust. Unfortunately, with those flashy doubles also come big declines. Yes, you may score some touchdowns, but you will also turn the ball over a lot more. In investing as in football, it is the team that turns it over the least that tends to win the game. Do we want to see capital gains? Of course we do, but we also want to avoid disastrous losses. NOBODY IS 100% PERFECT Does that mean that every pick is going to be profitable? Of course not. There will be losing picks. Let me repeat: there will be losing picks. However, my aim will be to cut the losers early to minimize losses and let the winners run to maximize gains. But, not so far as to result in a low current yield. To go back to the football analogy, I might get stuffed at the line of scrimmage and thrown for a two yard loss and have to punt, but I will avoid turning the ball over deep in my own territory. One of the key tools for avoiding big losses will be the Zacks Rank. Since the Zacks Rank is a short-term trading tool, and dividend investing is about investing more than trading, the Zacks Rank will be less of a factor in making Buy recommendations than in the other Zacks Trading Services. It will however be a critical tool in telling me when to get out of a name to avoid the big loss. A poor Zacks rank (Four or Five) usually indicates that the earnings prospects for a firm are deteriorating, either because analysts are slashing their estimates, or because the company reported earnings well below expectations. Ultimately, dividends have to be paid out of earnings. And, if earnings are deteriorating, so are the prospects for growing the dividend. If the deterioration is bad enough, even the current dividend is in danger. DIVIDEND INVESTING IS VALUE INVESTING The dividend yield is, like other price oriented metrics, a good indication of value. When the price goes down, the yield will rise. That then attracts new investors to the stock. Thus dividend paying stocks tend to be less volatile than non, or very low, dividend paying stocks. This is more of a tortoise than a hare approach to investing. It would be pretty silly to buy a stock for its dividend, only to sell it a few weeks later before you even get the first dividend. 3

5 When you think about it, there are just a handful of things that a company can do with its cash. It can invest in its current business, (say by building a new factory), it can pay down whatever debt it has, it can buy other companies, it can buy back its own stock, and it can return the cash to shareholders. Investing in the current business is often the best option, but much of the time, doing so faces diminishing returns. As long as the company has a solid balance sheet, paying down debt is often not the best option. Buying other companies is usually the worst option, since a premium has to be paid and the synergies the investment bankers promise don t pan out most of the time. Both share repurchase and dividends return cash to shareholders, but announced 4 repurchase plans can be quietly cancelled. Investors know if the dividend is cut or omitted. When you invest in a stock, you are putting cash in today in the hope of getting more cash in the future. Even if a company pays no dividend now, the hope is that they can take the profits that they earn back into the business to produce even more earnings, and thus at some point in the future, be able to pay out even more in dividends. Value investing is about comparing the price of a stock to its underlying value. Thus most value metrics are Price to s. Price to earnings, price to book, etc. Well the dividend yield is also a Price to, only it is expressed in an inverted fashion, Dividend to Price. Of all the metrics, the dividend is the hardest to manipulate. Value and growth are often portrayed as polar opposites in investing. I do not share that view. There is a value to growth. When I recommend a stock, I would love to be able to hold it for a very long time. I want to see the dividends increase year after year. I like to think of what will be the yield on cost at the end of the holding period. For example, assume you buy a stock trading at $50 per share. It retains most of its earnings now, but still pays an annual dividend of $1.75 per share, for a dividend yield of 3.5% ($1.75/$50). Say the company decides to start paying out more of its earnings in dividends however. If it raises its dividend by 15% per year over the next decade, at the end of year 10, you ll be getting $7.08 in dividends per share. That means your yield on cost will be a whopping 14.2% ($7.08/$50). And this ignores any capital gains you might have too. That s how you fund a comfortable retirement IF SOMETHING SOUNDS TOO GOOD TO BE TRUE Beware the siren call of high-yielding stocks, especially those with poor underlying business fundamentals. That juicy dividend yield can seem alluring, but they can and often do wind up getting cut. 4

6 One important metric to consider when analyzing the sustainability of a company s dividend is its payout ratio. This is simply the percentage of net income a company pays out in dividends. Or better yet, calculate the percentage of cash flow a company pays out in dividends. If a company is consistently paying out more in dividends than it generates in cash, that should be a red flag to investors that the dividend may get cut. Especially if its debt levels are high. Because those payments will get sent out before the dividend checks do. And if a company is paying out all of its earnings in dividends, it won t have anything left over to grow the business. It must then raise capital by issuing debt or additional shares to fund its growth. And that can be a dangerous game. Ideally, a dividend-paying firm will retain a portion of its earnings to reinvest back into the business. A high payout ratio isn t necessarily bad, however. Master Limited Partnerships (MLPs) and Real Estate Investment Trusts (REITs), for instance, pay out the majority of their income in the form of dividends to avoid double taxation. Utilities and other mature, slow-growing companies often have high payout ratios that are generally very safe. TAXES Our portfolio will include foreign stocks, MLPs, REITs and other high-yielding securities that may be subject to unique tax situations. So please be aware that there may be some additional paperwork come tax time. For example, MLPs held in a retirement account are subject to unrelated business income tax (UBIT) after the first $1,000 of net income. Since an MLP is a pass through entity, the retirement account would be considered to be earning this sort of income, and it would owe taxes to Uncle Sam. We recommend consulting a tax advisor on these special tax situations. 5

7 Section 2: Getting the Most Out of Income Investor It is our job to provide you with timely and profitable picks, but there are steps that you can take to ensure your success with Income Investor. Here are a few things you can do to get the most out of the product. 1. Read this guide carefully This guide is your friend. It has valuable information on how to use the product and succeed with the assistance of Income Investor. It gives you step-by-step instructions on how to receive alerts and what to do when you receive them. It has important money management tips. 2. Have a working address This is necessary to receive trading alerts. Make sure you can access your in a timely fashion because acting on trades is essential to success. The Summary will be sent at 8:00 p.m. EST, which summarizes the positions as well as what happened on Wall Street during that trading day. Intra-day trading alerts, while rare, will typically be sent within the first hours of the trading day. Unfortunately, many Internet service providers have software programs that filter out s you want to receive, like Zacks Income Investor Summaries. To get optimal delivery of our s follow this link for quick and easy instructions. 3. Have an online trading account We do not promote any particular company for this, but ideally lower commissions will help you achieve higher overall returns. You will make several trades a month, and high commissions can really eat into your profit margins, especially if you have limited capital. 4. Access the site To access the site, go to and enter your username and password. This will take you to the main page where you can view the portfolio, any pending trades, and the commentary. 6

8 Section 3: Follow the Leader The process to receive our trades is very simple, yet we feel it is so important that we are going to spell it out for you. Here are the four steps: 1. Receive the with the daily summary or intra-day signal 2. Read the to determine appropriate action 3. Place trades through your broker 4. Follow the s to determine when to sell ACT PROMPTLY = MOST SUCCESS And if you don t beat the market, you can take advantage of our 100% Money Back Guarantee. SPEAKING OF THE GUARANTEE... We feel that if we are not able to live up to our word and help you beat the market then we shouldn t be deemed worthy enough to take your money. So in addition to the 90-day, no hassle guarantee, there is a 100% Money Back Performance Guarantee. There are a few conditions that have to be met first, but the bottom line is that we have to perform. Click here for details. 7

9 Section 4: How to Read Income Investor Alerts This strategy will often have a trading alert during the trading day. When a Buy, Sell, or Intraday Alert is sent out, you should receive the alert within the first hours of the trading day detailing what stock or stocks are being added or sold and the rationale behind the move. It is important that you act as soon as you can. Here is an example: Signal = There is an additions section listing any stock position to initiate. The deletions section details any stock position to close. Company Name = The name of the company that is being added to or sold from the Income Investor portfolio. Symbol = Ticker symbol of stock being added to or deleted from the portfolio. Date Added = The date on which the stock was added to the portfolio. The alert will also show the current price at which the stock is trading, as well as the yield and industry of the recommendation. Income Investor Portfolio Commentary = As part of the alert, I will explain their rationale for the trades. You will learn the reasons for adding or selling the position. Intraday alerts typically use the average of the price at the time of the alert and the closing price that day. 8

10 Section 5: How to Read the Income Investor Daily Summary The Summary provides a wide array of details for Income Investor each trading day. This summary may have new signals as well as the current open portfolio with commentary. The commentary on individual stock holdings will help provide a game plan for those holdings. It will also suggest which stocks to write calls against and at what strike prices. Relative to other Zacks Trading Services I tend to write more about the overall state of the economy, and that sometimes strays over into politics. I do not intend to use the commentary as a political soapbox, but it is often impossible to comment intelligently about the economy without a discussion of what economic policy makers are doing, or should do. This is ed to you around 8:00 p.m. EST. In regards to the price added for the portfolio, Zacks typically uses the average of the price at the open and the closing price on the day the stock is added and deleted. 9

11 Section 6: Virtues of Money Management Money management can be the difference between realizing large gains and going broke, even if the winning percentage is the same. How can this be? The key point is that winning investors know to ride their winners and cut their losses quickly, and stick with a plan that has proven to work in the past. Here are a few rules that you can follow to further improve your returns: This portfolio will typically hold about 30 positions. Even though Income Investor will be a lower risk strategy than the other Zacks Trading services, it is still investing in the stock market, and Wall Street is not a one way street (well technically it is, running West to East, but it does not always go up). Do not invest in these names if you are going to need to use that money to pay the rent or the mortgage next month. Also, while I am looking for dividends that will grow over time, the primary focus is going to be on firms that have high current yields, generally over 3.0%. Even if you are fully on board with the idea of dividends and the importance of them over time, you may want to keep part of your portfolio in stocks that yield less today, but will grow those dividends at a faster rate over time. After five years, a stock with a 1.5% yield today, but which can grow its dividend at 20% per year, will be paying out more than the current 3% yielder that only increases its payout by 3% per year. Keep in mind that reinvesting profits and the power of compounding are your friends in this portfolio. Since dividends will obviously be a key part of this service, consider enrolling in Dividend Reinvestment Plans which put the current dividends into additional shares and allow the profits to compound over time. 10

12 Section 7: Ever-Present Cliché Rings True It has been said millions of times before, but it is so important it needs to be said again: Don t put all your eggs in one basket. Even if you are the most brilliant investor in the world, there is no way of knowing for sure that an investment will go your way. There will be losing trades. The key is staying in the game and building your equity over time in a systematic way. This can only be done when diversification is put to use. Not that we have to remind you, but the main point is that your capital was earned through years and years of hard work. Capital conservation sounds boring, but without it, you are fighting a losing battle. We don t want to see the money you have put your blood, sweat, and tears into evaporate due to lack of discipline. In Conclusion It is our goal at Zacks to enhance your investing results via the Income Investor service. This booklet touches upon the details of the service and provides several useful tips to realize the vast potential that these stocks hold. We feel it is our job to let you know that we are here to help you get the most out of the Income Investor. We have free customer support that should be taken advantage of. Any additional questions that you may have can be answered by just picking up the phone and giving us a call or ing us: (outside the US, ) Incomeinvestor@zacks.com 11