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Picking stocks

There are many nice things about having your own television show but the one I like best of all is that you can ask smart guys or gals with access to great research teams to answer money questions that I and my readers and viewers care about.

It’s the ultimate shortcut to instant gratification, at least in money terms.

Right time to ask

In case you missed it, I now have a show on Sky News Business Channel with the unlikely name of SWITZER. This week I asked Justin O’Brien from Morgan Stanley Smith Barney to give the best ten dividend-paying stocks on the Aussie stock market. The time is right for this important question, even though the market has shot up over 30 per cent. Whether there’s an eventual sell-off of this red-hot stock market or not, it’s becoming clear that the March lows are behind us and it could be safe to start looking at shares again.

The reason why I asked O’Brien to give us the name of the best 10 dividend-payers was because history has shown that if shares return around 10 to 12 per cent on average, then half of that return comes from dividends. The other half comes from capital gain which happens when the share price heads up.

The one problem with smart guys like O’Brien is that they’re smart and don’t always want to do as they’re told, but it’s usually for good reasons. He argued with me that picking the best dividend stocks could mean you end up in an income trap. That’s chasing income that might not be as good as their history, and it could mean you don’t end up with a good mix of shares.

Diversified portfolio

Many experts say your portfolio should be diversified to reflect the overall stock market and it means if one sector, like financials, is creamed, other sectors in your portfolio will offset them.

He showed me that if you look at the S&P/ASX 200, this is how the types of shares divide up the market:
Financials - 37 per cent

  • Materials - 26 per cent
  • Consumer Services - 11 per cent
  • Industrials - six per cent
  • Oil and Gas - six per cent
  • Healthcare - four per cent
  • Telecommunications - five per cent
  • Consumer Goods - 2.5 per cent
  • Utilities - 2.5 per cent.

And while you don’t have to stick to these proportions, they’re a good guide to making your portfolio reflects the overall market.

O’Brien said when you go for dividend only shares, you cut out the likes of BHP Billiton that pays a small dividend but can really kick butt on the share price side of the equation. He cited others such as Cochlear and CSL, which are really good companies with enormous potential.

A balanced diet

He said going for dividend only shares is like eating only vegetables instead of having a balanced “meat and three veg” approach to eating. Investing in a balanced way, like living a balanced life, seems to have a lot of merit.

And while I accepted his logic, I still made O’Brien deliver on his initial promise and we debated out his concerns on the program. It actually made for good TV and education — that’s why I am sharing it with you now.

Top tens

So here are the top ten dividend paying companies, and he cited the research from Citigroup based on what is called gross yields:

  1. Tabcorp
  2. Telstra
  3. Stockland
  4. Telecom NZ
  5. ANZ
  6. Commonwealth Bank,
  7. Westfield
  8. Westpac
  9. AMP
  10. Origin.

Up against this, O’Brien pits his preferred, or core portfolio, which is:

  1. ANZ
  2. BHP
  3. Cochlear or CSL
  4. QBE
  5. Santos
  6. Toll Holdings
  7. Westpac
  8. Westfield
  9. Woodside
  10. Woolworths.

This core portfolio is tipped to have the right balance between yield from dividends and the potential to enjoy capital gain as the stock market repairs the damage from the Crash of 2008.

A matter of exposure

Experts are divided on how many stocks you should have in your portfolio. Some like only 10, but that means you have a 10 per cent exposure to one company having a shocker. I like 20 companies as this reduces your exposure to only five per cent or to one CEO who might make a bad decision.

You could be tempted to put these two portfolios together. This would make your portfolio less balanced, but you would enjoy the best of two worlds — income and a balanced portfolio with good capital gain potential.

Science or history

The construction of a portfolio is not a science, but O’Brien’s approach is more scientific than my chase the stellar dividend payers. I suggest it’s a more historical approach based on the importance of dividends in explaining the average returns from the stock market over time.

Given this, it makes perfect sense to chase the good payers, but you do have to keep your fingers crossed that history can be trusted to predict the future.

By the way, the history of finance shows that history can let you down but in the absence of anything else, it’s always a good start.

Need help with your share portfolio? Click here to book a complimentary initial appointment with a Switzer financial planner today.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Tuesday, August 04, 2009

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