Blue chip dividends are a key part of successful investing

The best blue chips offer both capital gains growth potential and regular income through blue chip dividends. The dividend yield is certainly one of the most concrete indicators of a sound investment. It is the percentage you get when you divide the current yearly dividend payment by the share or unit price of the investment. It’s an indicator we pay especially close attention to when we select stocks to recommend in our investment newsletters.

Stick to dividend payers and you’ll avoid most of the market’s greatest disasters.

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Blue chip dividends and stock buybacks

It’s odd that while investors periodically crave cash dividends, they rarely get excited about stock buybacks. But in some ways, stock buybacks are better than dividends. In particular, they give you a tax-deferral option that you don’t get with cash dividends.

Stock buybacks raise the value of a given stock holding in two ways:

First, stock buybacks raise a company’s earnings per share. It’s simple arithmetic: buybacks reduce the number of shares outstanding. To get earnings per share, you divide total earnings by the number of shares outstanding. When you reduce the divisor—because the company has fewer shares outstanding, due to stock buybacks—the calculation gives you a higher number for earnings per share as an answer. On the whole, buyers are willing to pay slightly more for a stock with slightly higher earnings per share.

Second, when the company buys back its own stock in the market, it bids up the price of the stock.

When you hold a stock in your personal, taxable account and it pays a cash dividend, you have to pay tax on the dividend in the year in which you receive it. If the company instead devotes the cash to a stock buyback, you have two options:

• If you need cash, you can sell part of your holding in the stock, presumably at a higher price than you’d get in the absence of a buyback. If you do that, you’ll only pay taxes on the sale if the stock has moved up since you bought. If the stock has moved sideways or down, the proceeds of your sale are tax-free.
• Of course, you’ll always have the option of holding on to your stock until it suits your purposes to sell.

This added opportunity for tax deferral may not seem like much of an advantage in any single year. However, the magic of compound interest applies to that tax deferral. It can add up to a huge advantage over a decade or two.

Blue chip dividends from consumer product companies

We like high-quality blue chip consumer product companies because they can provide stability during a recession or economic slowdown. Typically, consumer products companies sell staples, like soap, soup and beverages that consumers must buy no matter what the economy is doing.

Strong consumer product companies share a number of characteristics. These include geographic diversity to protect them from regional economic difficulties, a record of rising cash flow and strong balance sheets. All these are characteristics of blue chip consumer stocks.

The spike in commodity prices in the early part of this decade pushed many consumer product companies to deeply cut their costs. Now that commodity prices have moved down, it has ended up letting them boost their profits as well as free up cash for expanding and upgrading their operations, or for increasing their dividends.

We believe that a record of increasing dividend payments is a good indication of a strong company, especially in a slow economy. High-quality blue chip stocks will usually be in a position to remain profitable during almost any type of economic hardship or recession. Plus, you get paid blue chip dividends and earn income while you hold these stocks even if share prices are falling.

Investor bonus: How to become a successful investor and receive blue chip dividends

We think investors should invest the bulk of their investment portfolios in a well-diversified group of high-quality, mostly dividend-paying stocks.

No matter what kind of stocks you invest in, you should take care to spread your money out across most if not all of the five main economic sectors: Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.

By diversifying across most if not all of the five sectors, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or investor fashion.

Has investing in stock buybacks turned into profit for you? Have holdings in consumer product companies led you to dividend income?