Like many married couples, my wife Carole and I are addicted to Netflix. Last night, we watched (again) “The Wolf of Wall Street” (2013), starring Leonardo DiCaprio as the ruthless investment adviser Jordan Belfort.

The movie starts with Belfort’s first day as a stockbroker for L.F. Rothschild, a date that fell on October 19, 1987. As DiCaprio drawls in the voice-over narration:

“They called it Black Monday. By 4:00 p.m. the market had dropped 508 points, the biggest plummet since the crash. Within a month L.F. Rothschild, an institution since 1899, closed its doors.”

On Black Monday, global stock markets crashed. The Dow Jones Industrial Average fell to 1,738.74, for a one-day loss of 22.6%. Major culprits for the crash included program trading. Fears over the rise of artificial intelligence (AI) have resurrected this worry on Wall Street.

But so far this year, we’ve been enjoying a stock market rally. The bear market of 2022 has become a distant memory.

The S&P 500 currently hovers above its 50- and 200-day moving averages, indicating sustainable momentum. The New York Stock Exchange Advance/Decline line (NYAD) also hovers above those key averages, indicating greater market breadth.

Leading the rally have been technology stocks, which took a massive beating in 2022. Tech shares have rebounded, as investor enthusiasm (albeit with an undercurrent of social trepidation) builds over AI.

Here’s the lesson: Don’t buy stocks that you’d probably sell in a Black Monday-type panic. Methodically build a portfolio that you’d want to hold through good times and bad. Accordingly, if you’re an income investor in search of robust dividends, keep your sense of perspective and follow my all-weather advice below.

I’ll only take five minutes (or thereabouts) of your time.

1987 Redux?

The main U.S. stock market indices on Thursday took a breather from their recent run-up and closed mostly lower, as follows:

• DJIA: +0.47%
• S&P 500: -0.68%
• NASDAQ: -2.05%
• Russell 2000: -0.89%

Nothing as bad as 1987 (or 2008) appears to be in the cards right now, but you must contend with the constant threat of sell-offs until we get clarity on several unknowns. We still face a litany of risks.

The Federal Reserve’s next meeting is July 25-26, and if the central bank continues to display hawkishness, it could undermine the economy and the equity rally. The Russia-Ukraine war could take a turn for the worse. Russian President Vladimir Putin is behaving like a cornered animal and he’s been rattling his nuclear saber. Inflation has been cooling, but if we get unexpectedly hot inflation data, investors might panic.

China’s economy has been decelerating, with second-quarter 2023 gross domestic product numbers missing forecasts. America’s relations with China have been deteriorating, and Taiwan could erupt as a geopolitical flash point.

And yet, the major indices in the U.S. and overseas have been soaring. Risk-on assets have come back into vogue. But don’t give short shrift to quality dividend-paying stocks. They have a lot to offer. Dividend payers provide potential income growth and share-price appreciation, as well as ballast for your portfolio.

Want to rev-up your income portfolio? I’ll show you how.

Traditional income havens such as real estate investment trusts (REITs), master limited partnerships (MLPs), and utilities are conventional sources of dividend income.

Despite the surge in bond yields due to the Federal Reserve’s tightening cycle, exchange-traded funds (ETFs) that focus on dividend stocks have recorded increasing inflows of investor capital. Keep in mind, dividend stocks have generated higher absolute returns than bonds during all meaningful time periods.

The key is to pick the right dividend stocks or funds. When looking for dividend stocks, it’s tempting to gravitate towards securities with the highest yields. This is not always the smartest strategy; there’s more to a worthwhile dividend stock than just a high yield.

Stocks that can generate steady and sustainable dividend growth, rather than the fattest yields, are better bets for dividend investors.

Sure, robust dividends are offered by well-known companies with solid balance sheets. But income investors often lose sight of the fact that high dividends also can be used by new or weak companies as bait for investors.

Beware the dividend trap…

A “dividend trap” is when investors hungry for yield are suckered into a high dividend yield, only to eventually discover that the underlying company is deeply troubled. That’s when the dividend gets cut or eliminated and unsuspecting investors get hurt.

WATCH THIS VIDEO: Ouch! The 10 Warning Signs of a Dividend Trap

Always look for healthy payout ratios, plenty of cash on hand, and a history of earnings growth. These quality dividend payers demonstrate greater resilience during an environment of rising rates and market volatility.

When investing in dividend-paying stocks, investors need to be mindful of the trade-off between risk and reward. If a company suddenly can’t generate enough cash flow to support its dividend, it may cut the dividend or get rid of it altogether.

To determine the safety of a company’s dividend, investors look to the payout ratio.

Healthy businesses generate large amounts of cash flow and earnings. For a dividend to be sustainable, the amount paid out to investors must be well covered by the amount of cash coming into the business. How well the dividend is covered by actual cash is measured by the payout ratio.

Payout Ratio = Dividends Per Share / Earnings Per Share

The lower the payout ratio, the more resistant a company’s dividend payouts will be to future declines in earnings. A company with a high payout ratio distributes a significant portion of its current profits to shareholders, while a company with a low payout ratio distributes a small portion of its profits in dividends.

If future earnings decline for a company with a low payout ratio, it’s still likely to generate enough cash flow to support dividend payments. Moreover, because companies with low payout ratios pay out only a small percentage of their profits, they are more likely to have room to increase future dividends than companies with high payout ratios.

Look to the Aristocrats…

The so-called “Dividend Aristocrats” always provide fertile ground for income investors. To earn the honorific Dividend Aristocrat, a company must typically have raised dividends for at least 25 years. More precisely, the company needs to have a managed dividend policy that increased its dividend every year for those 25 years.

These dividend powerhouses constitute the S&P 500 High Yield Dividend Aristocrat Index, an official index of the 50-plus highest dividend yielding stocks in the S&P Composite 1500. This Aristocrat Index is maintained by Standard & Poor’s, which every December updates the list of companies that make the grade.

By its very nature, a Dividend Aristocrat tends to be a large and stable blue-chip company with a strong balance sheet. Many of these companies are familiar names that produce household brands. Because of their strong balance sheets and financial wherewithal, they tend to weather market ups and downs.

Here are two cases in point. During the 2008 crash, the Dividend Aristocrat Index fell 22%, whereas the S&P 500 index fell 38%.

In 2022, during the punishing bear market, the benchmark ETF ProShares S&P 500 Dividend Aristocrats (NOBL) fell -6.52%, versus -18.11% for the S&P 500 and 32.38% for the tech-heavy NASDAQ (see chart).

Dividend growth investors should focus on buying and holding high quality businesses for the long run. Think of time as the currency of your investment life. And with that, my five minutes (more or less) are up.

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John Persinos is the editorial director of Investing Daily.

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