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Buying Stocks on the Cheap

I like beaten-down stocks with solid dividends. But management counts, too.

When last we left our heroine, she was anxiously waiting for Kiplinger's trading restrictions to lapse so that she could snap up a bunch of bargain-priced blue-chip stocks before too many other investors realized they were being far too dismissive of these great companies.

The market was kind enough to tumble just as the trading restrictions expired, making this Practical In­vestor feel like a kid in a candy store. Lockheed Martin (symbol LMT) at $76.70? Yes, please! Chevron (CVX) at less than 8 times earnings? Sweet! Apple (AAPL) at $390 and Microsoft (MSFT) at a shade over $25? I bought them all.

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Good moves. The timing was fortuitous. From December 12, the day of my latest buys, Apple rose 8%, Chevron gained 6%, Lockheed climbed 4%, and Microsoft soared 11% (all figures are as of January 6 and include reinvested dividends). Over the same period, Standard & Poor's 500-stock index gained 4%.

What about the rest of the portfolio? You can see all of my buys here. (I haven't sold anything yet). But before you start to check up on my perform­ance, you might want to learn how I'm trading and keeping score.

I buy stocks in bunches and measure their perform­ance against Vanguard Total Stock Market ETF (VTI). By looking at this exchange-traded fund, I can see how individual stocks have fared in comparison with a volatile market. Because I launched this portfolio just a few months ago, I have only short-term results to assess. A year from now, we'll be able to make more-meaningful judgments about my picks.

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In the meantime, let's see what my picks have done so far. Two of my three initial purchases -- Intel (INTC) and Spirit Airlines (SAVE) -- gained 11% and 4%, respectively; Corning (GLW) fell 2%. My ETF has lost 1% since October 27, when I bought the next group of shares. Meanwhile, Johnson & Johnson (JNJ) was flat, PPL Corp. (PPL) fell 2%, and KKR Financial Holdings (KFN) rose 7%.

So far, three of the ten stocks I've purchased haven't beaten the index. The worst performer -- Corning, a maker of shatter-resistant glass for phones and TVs -- got slammed when the company announced in November that it expected revenues to decline in the fourth quarter. But with the stock, at $14, selling for a bit more than 6 times the past 12 months' earnings per share, it doesn't strike me as a time to get out.

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Corning's decline notwithstanding, all of my picks share common themes: I seek to buy good companies when they sell at cheap prices and try to cover my bet by favoring those that pay rich dividends and generate enough cash to pay them. In fact, half of the stocks in my portfolio owe a portion of their return to reinvested quarterly dividend payments that bought me more shares.

But if historically cheap prices and generous dividends are key, why am I not pouncing on a stock such as Hewlett-Packard (HPQ), which sells for less than 7 times earnings and yields 1.8%? Because of the amorphous “governance” aspect of stock selection that I wrote about last month.

A company's board of directors is supposed to serve as a steward of investor assets, overseeing top management and ensuring that shareholder money is well spent. HP's board has proved to be a horrible steward. It has hired lousy executives, then lavished them with millions of dollars after firing them. In 2010, Mark Hurd walked away with $23 million, including $12.2 million in severance. The board fired Hurd's replacement, Léo Apotheker, after just ten months on the job, awarding him a parting package estimated at $25 million.

Most corporate waste flies under the radar. So when it jumps out at you, you know the company's directors can't be trusted with your hard-earned money. In HP's case, that makes an apparently cheap stock not cheap enough.

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