The Strategy for Capital Gains That’s Proven to Work

dividend paying stocksThe stock market is holding up well and it has performed strongly since the beginning of the year. I don’t want to rain on its parade, but I do want to mention that Street analysts have been quietly revising a lot of earnings outlooks lower, especially for the bottom half of this year. We still have reasonable share price valuations and the stock market can certainly tick higher over the coming quarters, but I think investors should keep in mind that earnings growth, while good, isn’t robust.

As an investment strategy for the stock market, I continue to be keen on those companies that generate a significant amount of income for shareholders. Stocks that pay higher rates of dividends are key, as far as I’m concerned. We are in the age of austerity and, in an era of slow growth, you can’t expect much from the stock market. Government spending is going to become more constrained after the election and Europe’s sovereign debt troubles are not going away; they are just being delayed with more debt.

From my perspective, dividends are absolutely a very important part of your expected returns from the stock market in the era we’re in. Corporate balance sheets are in good shape and, with the expectation of a slowdown in corporate earnings (from now through to 2014), dividend payments are not expected to be cut. In fact, dividend payout rates are likely to increase because of all that cash on corporate balance sheets. (See Stock Market Leaders Under Pressure—Dividends to Become the Market’s New Best Friend.)

The great thing about higher dividend paying stocks in this kind of environment is that you don’t have to expect minimal capital gains. All kinds of big-cap companies that pay dividends generated excellent capital gains over the last couple of years. You no longer have to approach the stock market with small-caps in mind if you want to make money. Institutional investors have made the leap to dividend paying stocks because of all the uncertainty out there and we’ve seen big, brand-name companies perform like high-flying technology stocks—consider Caterpillar Inc. (NYSE/CAT), McDonald’s Corporation (NYSE/MCD) and ConocoPhillips (NYSE/COP).

Because of the sovereign debt that’s accumulated in most mature economies, flexibility for policymakers is slowly eroding, year-by-year. The threat of war in Middle East is real and so is the destabilization of the euro currency. The U.S. housing market still has a lot of inventory to get through and price inflation for raw materials is hurting purchase power. What I’m getting at is that the uncertainty in the world and the amount of investment risk in the stock market continue to be very high. This is why dividends and income are so important if you want to be a buyer of new positions in the stock market. Dividends have been investors’ only real friend for some time. We’re still in a bear market. It’s been going on for over 11 years now.