Investor's Corner: Focus On Earnings And Sales, Not Yields

Stocks that pay dividends yields may sound attractive to investors.

After all, getting a few extra percentage points on top of the capital appreciation (when you are right) may be the financial equivalent of having a cherry on top of your sundae.

But while dividends are a nice bonus, and income stocks make sense for some portfolios, don't base your selection just on yields.

IBD's studies of the best-performing stocks found yields have little bearing on stocks' success.

Instead, investors can reap the best gains by focusing on companies showing the strongest earnings and sales growth, other solid fundamentals and institutional sponsorship.

It's a firm's ability to deliver quarter after quarter and year after year of robust profit and revenue increases that will ultimately drive share prices higher.

How much growth should you look for? Quarterly earnings should be up at least 25%.

Likewise, sales should also be strong. Insist on quarterly gains of at least 25%. Look for strong annual gains, too.

You want to see that business is actually booming and that the bottom line isn't being boosted by lower costs.

Mosaic (NYSE:MOS - News), a maker of phosphate and potash fertilizers, recently reported a 433% surge in quarterly earnings and a 44% jump in sales. The stock, a big winner in 2007, pays no dividend.

You typically don't see growth numbers like these in stocks that pay dividends.

Why? Typically, companies enjoying strong growth prefer to reinvest their earnings back into the business to further their growth.

Companies that offer dividends, by comparison, tend to be mature enterprises, whose best growth periods are behind them.

Also, many dividend-paying companies are in relatively stable industries such as utilities, and REITs.

In 2003, the government cut the tax rate on dividends, and dividends expanded. Yet, there was little if any impact on stock returns.

A study by the Federal Reserve found that stocks that pay no dividend outperformed those that do, by a small margin.

Although it's nice to sit back and collect a dividend check each quarter, beware of the risks.

Bad news or even general market weakness can wipe out a year's worth of dividends in a heartbeat.

Also, companies can trim their payouts or eliminate them when they come under financial stress.

The fallout in the subprime mortgage industry has been hard on many financial firms. Some have been forced to slash their payouts.

On Jan. 8, mortgage bond insurer MBIA (NYSE:MBI - News), already weakening, gave bad news on its dividend.

It slashed its quarterly payout by 62% to 13 cents a share from 34 cents in an attempt to preserve cash. The stock plunged 21% on the news.