Financial Stocks in your dividend portfolio

By: ispeculatornew
Date posted: 01.05.2011 (5:00 am) | Write a Comment  (4 Comments)

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If you are reading this post, chances are that you are a believer in the importance of passive income and that dividend stocks are an important portion of most passive income portfolios. If that is the case, it is very likely that you have a few financial companies in your portfolio or that you are looking to add some in the near future. How can I tell? Financial companies represent the most important sector of the US economy as well as the stock market by most accounts. Not only that, but public financial companies are generally very good and reliable dividend payers. Or at least, that was the case before the most recent financial crisis.

The crisis

Lehman Brothers and Bear Sterns were two of the very large US financial institutions that ended up collapsing as victims of the recent financial collapse but there were many other victims. Needless to say that shareholders of most financial companies lived a major roller-coaster, some got off too early because they were unable to live through all of the highs and lows.  Many considered the financial sector to be almost without risk and had their entire dividend portfolio invested in financial companies. Needless to say that proved to be a major mistake.

The 2011 mistake?

As big of a mistake as being all in on financial stocks turned out to be, I think the bigger mistake would be avoiding the sector altogether in your dividend portfolio for 2011. The facts are that the financial sector had a terrible couple of years and remains vulnerable to some extent. But there are still many very good opportunities for dividend investors and putting the entire sector in the same basket would be a big mistake. Besides, putting the entire financial sector in one basket would be a terrible mistake. Some companies do retail banking, others are traders, brokers on investment banking deals, etc. I think it’s important to take a look at the possibilities for this sector and include a few names. If the economy suffers another blow, these stocks will surely suffer, but so will others.

Filtering through

I decided to take 30 financial companies from the S&P500 and look for the better dividend plays. Those are debatable of course but I would love to hear your thoughts on my findings. First off, I decided to take out companies that do not pay dividends (such as Citigroup-C).

Then, I removed companies that pay less than 1% of annual dividends (such as Goldman Sachs-GS or Visa-V) which left me with 13 companies! Once I took out the companies with too much debt (debt to capital over 30%) such as the CME Group and companies that have a payout ratio over 50% such as Paychex-PAYX, I was left with only 5 companies:

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Tricky part

For me, the tricky part in investing in financials is that some of these companies are so complex that understanding their risks and balance sheets becomes a full time job. Warren Buffet likes to invest (generally) in “simple business”. I would think that a company like Western Union for example would be a simple enough business and could be a good dividend play.

What are your thoughts on these and other financial companies in your passive income portfolio?

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4 Comments

  1. Comment by jim — January 5, 2011 @ 9:14 pm

    H&R block is a pretty simple business – it does tax. Also, I would argue that its less finance business and more a service business and should be treated as such. There is a big difference between a bank / broking house that uses its own balance sheet and a service business.

  2. Comment by IS — January 6, 2011 @ 8:04 pm

    @jim – Thanks for the comment! While I do agree that H&R Block is more simple than most others in this category, I would still classify it as such… but thanks for the input!

  3. Comment by JT — January 8, 2011 @ 9:21 pm

    I don’t agree with your criteria – eliminating currently low paying/no paying dividend stocks from your search. Many market followers believe juicy dividend raises will occur throughout many sectors this year and financial stocks should prove no exception. I believe we’ll see some impressive raises in the first quarter. It would be a shame to miss out because those stocks will jump on such announcements. I like JP Morgan here and think an announcement could follow after their earnings update next week. Also, I don’t expect a dividend this year, but Citibank should move up nicely throughout 2011 and begin paying a small dividend next year. Getting in now while below $5 is not a bad strategy. Thanks for the work you put into your site. I found it helpful throughout last year.

  4. Comment by IS — January 9, 2011 @ 11:12 am

    @JT – Many thanks for the good words! As for stocks like Citi, I see what you mean, I just find it much more difficult to evaluate and a bit more of a gamble. But it could prove a great one, I agree.

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