'Dividends Don't Lie'

A dividend is a distribution of company's earnings. It's a way for the owners of a company to collect an immediate return on their investment. And remember... when you own shares of stock, you hold a small ownership stake in that company.

Dividends are often quoted in terms of the "yield" they offer investors.

For example, if a stock has a share price of $10 and pays a $0.50 per share annual dividend, the "dividend yield" is 5%.

Smart, sophisticated investors have a saying about these payments made to shareholders: "Dividends don't lie."

Here's what I'm talking about: A good accountant can fudge 99% of the figures on a balance sheet or a profit statement. But he can't fake a cash payment.

For example, take Wall Street's favorite number – earnings. Earnings are subject to all sorts of bookkeeping adjustments like depreciation, reserve accounting, and different inventory valuations. Because investors pay attention to earnings more than any other number, it becomes really tempting to manipulate them.

But think about a dividend. A dividend is a fact. When companies pay their dividends, they mail out checks to every shareholder.

If a company is paying cash, it's hard to fake the numbers. The money leaves the bank and never comes back. It's that simple.

Regular dividend payments are a real mark of quality. The management and directors know their company better than anyone else. So when a company announces a dividend payout, it's saying, "We have cash we don't need."

A strong dividend payment almost always indicates a healthy business. The company is generating cash and wants to say "thank you" to shareholders.

And a company knows if it takes the dividend away suddenly, its stock will drop. It's not always easy to pay out cash to the shareholders every year...

Cash is a scarce resource, and it's critical to every business. So when companies are able to maintain their dividends through bad times, it sends a strong signal to the market that management knows what it's doing... that it has good control of its company's finances.

Similarly, rising dividends protect stock prices in bear markets. Thus, dividend stocks are by nature "defensive stocks." They protect your capital. A rising dividend acts like a pontoon float and prevents the stock price from falling much.

Finally, a dividend payment signals management's intention to reward investors for offering their capital. As a stock analyst, I place great weight on the dividend payments when I size up a company. A regular and increasing dividend payment is a sign of a healthy business.

For example, Coke is one of my favorite stocks. It has paid a dividend for 50 straight years. Or take one of my favorite drug-maker stocks, Eli Lilly. It has paid a dividend for 43 straight years.

These types of blue-chip companies carry much less price risk than the typical risky stock carries. They rarely fall 15% in a hurry, like the "hot" tech stock I discussed in our example.

However, blue-chip stocks aren't exciting enough for most people. Most people would rather gamble on risky technology stocks, or on something "exciting" like the initial public offering of Internet social-media service Facebook.

When it comes to selling options the Retirement Trader way... and generating safe income on your nest egg... we want big, safe, companies that plow relentlessly forward like a bulldozer. Those are the investments that allow us to sleep at night while owning them.

Listen to what subscriber A. M. told us about investing in blue chips...

I'm 63, own my own business, still working, & love Retirement Trader. I have made about $30,000 using Doc's tips. The list is long: Exelon, Microsoft, Medtronic, Intel, CVS, and more. I like it so much, I have taken back my professionally managed IRAs and intend to do them myself, using Doc's tips.

I have been an investor for 30-plus years. You name it, I have invested in it. Some good, some not so good. What I find most attractive about Doc's approach, is the relative low risk. If a put doesn't work out, I end up owning a great company, (hurt me again). It's literally the best approach I have ever seen, then used, then made money, consistently... – A.M.

We may not be able to predict which tech company will produce the next hot gadget. But it's a sure bet that tomorrow, people will still drink Coke, still buy burgers at McDonald's, and still use Johnson & Johnson's Band-Aids. They'll be doing all this 10 years from now.

By sticking with blue chips in our covered call strategies, we don't mind if our shares decline a little. We still collect premiums. We still collect dividends.

By sticking with blue chips with our put-selling strategies, we win either way. If the stock rises in price, we simply keep the premium. If the stock declines in price and we are "put" the stock, we don't mind. We end up buying a quality business at a price we think is a bargain. We can then start collecting dividends and covered call premiums.

Once again: Avoid the risky method of selling options...

Stick with the best! Stick with beachfront real estate! Stick with blue chips!

Take-home message:

• Avoid gambling on risky, "exciting" stocks.
• Focusing on blue-chip stocks lowers our risk of selling option.
• A common characteristic of great companies is a long history of growing dividend payments.