4 Ways to Diversify Your Dividend Income

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

You’ll hear it on every investment website.  In almost every stock newsletter.  It’s the hallmark of financial planners.  “Diversify your portfolio.”  The problem is that few explain “diversification” in detail.

What should investors diversify?  Should they diversify into equities and bonds, or should they add other assets?  If equities, what kind?  Consumer staples or cyclical, growth or value?  Often investors will harp “diversify,” but will give it no further instruction. 

A helpful way to think about diversification is to start with the biggest buckets, then to break them down into smaller buckets.

Here is an example.  Start with the broad category of stocks.  You can have growth stocks, international stocks, value plays, and dividend companies, to name just a few.  Let’s select dividend stocks.  Next, we can further break this group down into smaller segments to diversify this segment one step further.

To fully diversify the dividend segment, investors can compile different types of dividend stocks.  For example, the dividend payers can come from a variety of industries and countries, and they can include both cyclical and non-cyclical.  Recently I was conducting this type of research, and I came across four high-dividend paying companies across two distinct industries.  They are as follows.

Healthcare

Pfizer (NYSE: PFE) is a strong healthcare company.  The company has a market cap of $187.6 billion, a P/E of 18.8, and it pays a nice 3.5% dividend.  Moreover, Pfizer makes an array of consumer healthcare products, ranging from painkillers to prescription drugs.  Of course large pharmaceutical companies can experience volatility in share price if a new drug is denied by the FDA, but Pfizer’s stock is a little less volatile play than most drug makers.

Another nice dividend payer is Merck (NYSE: MRK).  With its $138.4 billion market cap, Merck is atop its industry.  Merck makes Celebrex, an Alzheimer’s drug.  It also makes drugs for pediatric and adult patients, and for animals.  Merck pays a hefty 3.6% dividend and trades at 20.8 times earnings.

The nice part of consumer healthcare companies like Pfizer and Merck is that, even in the midst of a deep recession, people will still pay for an over-the-counter drug to eliminate a headache.

Firearms and Ammo

The firearms and ammo industry is more cyclical.  For example, right now gun sales are skyrocketing as hunters fear that another Obama victory would limit their second amendment rights to own firearms.  As an example, The FBI conducted 12 million background checks for firearm sales through August 31, a 56% boost over 2008. 

Olin (NYSE: OLN), the maker of Winchester Thurston firearms and ammunition has exploded in growth amid new gun sales.  The company pays an incredible 3.7% dividend, has a $1.7 billion market cap, and trades at a P/E of 11.4.  If Obama wins another victory, retailers like Cabela’s are expecting major sales in the last two months of 2012.

Like Olin, Ruger (NYSE: RGR) has experienced strong growth.  The company trades around $44.50 amid new gun sales, under its 52-week high of $58.42.  Ruger, an $854.2 million company, pays a 3.4% dividend and trades at 15.8 times earnings.  Like Olin, Ruger is expecting major increases in gun sales if President Obama captures the next election.

Conclusion

To summarize, investors can diversify their portfolios by breaking the portfolio into different kinds of assets.  And within those major asset classes, investors can diversify even further by parsing into different categories like consumer staples, cyclical companies, and even companies with strong, stable cash flows.

So the next time a newsletter touts the benefits of diversification, remember that diversification occurs at the asset-class level.  But it also happens within each sub-category of assets as well.


ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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