Mr. Market And Mr. Fundamentals Team Up To Pick Income Stocks

I assume I don’t have to explain why so many investors (including me) crave income. But we know all too well that we can’t get a decent yield without taking some risks. Interestingly, though, Mr. Market, the mythical kook who supposedly can’t separate hype from substance, is more skilled than many realize when it comes to evaluating dividend risk.

Listening to Mr. Market . . . Seriously?

Contrary to the suggestions of Mr. Market’s father and publicist (Ben Graham and Warren Buffett, respectively), he can actually be worth listening to. It seems he has become a bit less manic-depressive over the years through use of meds that we refer to as “information.” In today’s world, it’s hard to argue that any stock does what it does due to investor ignorance. What might seem, at first glance, to be market insanity is actually a reflection of different goals, different agendas, or different interpretations of facts.

When we look at what Mr. Market does, instead of reflexively dismissing it and turning ourselves into doctrinaire contrarians, we should evaluate Mr. Market’s opinion the same way as we evaluate any other. And that starts with consideration of whether Mr. Market has demonstrated a talent for the kinds of decisions with which we’re concerned.

So let’s test him on income stocks.

We can recognize when he’s bullish when yields are at the lower end of the range; that would mean he bid those stock prices upward. Conversely, if he’s bearish (i.e. if he fears dividend cuts or eliminations, or drastic slowdown in the pace of dividend growth), he’ll be more a seller. That will drive prices down and, of course, result in higher yields.

I created an income stock universe on Portfolio123 and compared performance of hypothetical portfolios consisting of the lowest yields (not so low as to cause income investors to dismiss them; I mean low relative to other eligible choices) with the performance of a hypothetical portfolio consisting of the highest yielders. The results are shown in Table 1.

Table 1

An average yield of 12.6% on the high-yielding portfolio sounds great! Who worries about total return when you have that?