Five Rules Every Income Investor Should Follow

I consider myself a reasonably savvy person when it comes to picking stocks for all sorts of special reasons: growth, safety of principal, a barrier to unexpected market fluctuations, dividends, etc. But, let me begin this week's column by making one observation. The best hitters in baseball are considered great if they hit the ball three out of 10 times at bat. But if you pick only three winners out of every 10 stocks you invest in, you will find yourself out of business — FAST!

[Editor's Note: 7 Best Dividend Stocks to Invest In - Get Them! Click Here]

You see, in the stock picking business, you better get at least 6 - 7 out of 10 picks right or you will languish in the shadows of the also-rans. Knowing the facts, good judgment, patience, and good results are co-equals and go hand in hand.

And when you are trying to consistently and reliably select "good" dividend paying stocks, ones that give some principal safety and potential for price gains, that really requires close attention to all the details. I think it was Ross Perot that once said "The devil is in the details." Ah yes, the details. That seemingly good-looking dividend yield could easily be masking all sorts of potential problems with the stock — falling profits, poor management, and even potential bankruptcy.

So, let's talk about some of the more important details when it comes to successfully picking stocks for dividends, encapsulated in my Five Important Rules to follow when you are making those all important selections of income generating stocks.

But, before we begin, you may be asking yourself just where will we get the initial group of stocks to consider for our final selection? Let me suggest three efficient ways to do just that.

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First, look at stocks with which you are already familiar. Usually they will include some of the Dow 30 and the S&P 500, and surely some of the larger and more well-known NASDAQ stocks.

Second, a good source would be to read some of the stock newsletter services that specialize in dividend stock recommendations. Our own NewsMax group of advisors and newsletters is an excellent source to check out (of course, I am a bit bias, but believe me, they are a good lot to get to know!)

Third, you can also research some of the stock mutual funds that specialize in investing in dividend generating stocks. Usually their fees are quite reasonable and the published history of the fund is a quite reliable guide, given all the rules the Securities and Exchange Commission (SEC) requires for public disclosure.

Whatever method you use, limit your selections to stocks paying at least 6 percent or more in dividends. Treasury bonds pay about 5 percent at this point, so we certainly want a better return than these bonds for our portfolio, and a 6 percent dividend level gives us at least a 20 percent premium over the Treasuries.

Again, in the name of efficiency, I would advise that you try and end up with only 20 to 25 stocks and maybe 4 to 6 funds from which you will make your final choices. From this final group, try to diversify your final choices to 8 to 10 stocks and several funds. (Watch for our column next week that will talk about how to apply four simple rules that will help you efficiently diversify (or allocate as it is often called) your portfolio holdings to help protect its principal. You will find it a good companion to this week's column).

Now, here are the Five Important Rules that you should apply to your final stock choices.

Rule 1: Look at the dividend payout dollars per share each year for the last 10 years. It should be relatively consistent year to year and a mild uptrend is a real plus. Dependability is what you are looking for here.

Rule 2: Look at the stock price history for the last 10 years. If should be consistently on the uptrend over that period, as the best case scenario, with maybe a slip here and there allowable, as the economy may have hit a speed bump now and then. But, the price should have varied no more than 15 percent — 20 percent in any year-to-year period, as a general rule. Vitality in the company's approach to its market will be demonstrated by the record you see here.

Rule 3: Check the sales revenue over the ten-year period. It should show a fairly consistent uptrend. It doesn't have to be 20 percent — 30 percent year to year like the so-called "high flyers", but a steady increase is important, even if it is only in the mid-to-upper single digit area. Consistency and growth is important here.

Rule 4: Check the profit dollars per share year to year. Yes, that may vary a bit more than the other numbers, but a steady gain here is important. Remember, dividends are paid out of profits. If profits are volatile, the possibility that insufficient cash or profits might threaten dividends in some years is a definite risk. Good management is what you are looking for here.

Rule 5: Once each year carefully review the stocks you did invest in and be sure the first 4 rules still hold. Maintenance is as important in a portfolio as it is in good housekeeping. Allow the dust to get too thick and the cleanup job will not be a very pleasant one. This one is aimed at keeping you on your toes.

So, there you have a good guide to beginning to build a retirement portfolio for income using stock dividends. As I said in the beginning, you won't likely hit 100 percent in your picks, but being diligent, thorough, and cautious in your selection process and consistent in periodically reviewing your stock picks will help to ensure that you end up with a growing portfolio principal, a growing income level, and a growing sense of assurance that will lead to many a peaceful, sleep-filled night. And remember. Keep in touch. I do. See you next week.

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