Piddly 2013 Social Security COLA: Tips for Seniors Feeling the Need to Dive into Dividend Stocks.

We won’t know for another month what the exact 2013 cost-of- living adjustment for Social Security benefits will be. The annual adjustment is based on the year-over-year change in inflation for the third quarter. That said, both the Congressional Budget Office and the Social Security Administration expect next year’s inflation adjustment to be less than 2%.

That’s less than half the rate of increase in health care inflation over the past year.

US Health Care Inflation Rate Chart

US Health Care Inflation Rate data by YCharts

And anything under 2% is going to be less than a third of the increase in food costs.

Food Price Index Chart

Food Price Index data by YCharts

Add in at least two more years of the Federal Reserve’s zero-interest rate policy, and it’s pretty impossible for anyone living on a fixed income to generate any risk-free income.

6 Month Certificate of Deposit Rate Chart

6 Month Certificate of Deposit Rate data by YCharts

All that suggests that 2013 will be another year where income- starved investors continue to glom onto dividend paying stocks, where income yields are often 3% or higher.

And that can be a very risky move these days, as YCharts has reported in an article explaining the benefits of dividend growth.

Utilities and telecoms are classic widows and orphans dividend payers. But lately, some of the most popular dividend players have seen their valuations rise sharply, in large part because of the surge in interest in dividend payers. Folks in search of income are bidding up the prices for companies with moderate -- if not outright slow-earnings growth -- triggering big increases in PE ratios.

Among the utility sector, both Southern (SO) and Consolidated Edison (ED) have dividend yields of at least 4%. But look at what’s been happening to their PE ratio.

SO PE Ratio Chart

SO PE Ratio data by YCharts

Over in telecom land, AT&T’s (T) 4.7% dividend yield has clearly outweighed concerns that as a slow-grower it might be a bit expensive these days.

T PE Ratio Chart

T PE Ratio data by YCharts

While seniors on a fixed income may be feeling the need to venture into dividend paying stocks, a few rules of the road may help navigate through potholes.

First off, it’s still a stock. And even the most solid dividend paying stock is going to take its hits when the market falls.

The $9.5 billion SPDR S&P Dividend ETF (SDY), which focuses on firms with a long history of dividend increases, has a nice 3% yield and strong performance of late.

SDY Chart

SDY data by YCharts

But that chart belies the fact that when markets swoon, not even a 3% dividend is going to protect you like bonds.

Here’s what happened during the 2011 summer of debt-debacles (our debt-ceiling mess and a flare up in Europe’s as well):

SDY Chart

SDY data by YCharts

And here’s the chart every prospective dividend investor should use as a litmus test: 2008.

SDY Chart

SDY data by YCharts

You get the idea: dividend stocks are still stocks. Redeploy your cash and bonds into dividend payers with eyes wide open to the potential risk.

To help manage risk, focus on companies with a history of dividend growth and ample earnings growth and cash to keep the dividend payments coming. Using YCharts you can check a company’s dividend payout trend line and free cash flow. YCharts Pro provides a snapshot of a firm’s cash dividend payout ratio: the amount of the current total dividend payout relative to the cash kitty. The lower the better.

A few examples:

Abbott Labs (ABT) has a solid history of increasing its dividend, there’s also been a long-term rise in free cash, and the payout level is below 50%.

ABT Dividend Chart

ABT Dividend data by YCharts

Exxon Mobil’s (XOM) sub-10 PE ratio should please the value seekers. And the company tells a compelling dividend story as well:

XOM Dividend Chart

XOM Dividend data by YCharts

Intel’s (INTC) PE ratio is barely above 10, and it has become a standard bearer among the burgeoning dividend payers in the tech sector. INTC Dividend Chart

INTC Dividend data by YCharts

Those are just a few examples. Using the YCharts Stock Screener you can vet potential dividend stocks to make sure you’re not paying too much for yield.

Carla Fried is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

Read more articles about: Investing Ideas  

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