I don’t think there’s much money to be made buying stocks that are popular.

If I learned anything, as a stock picker, it’s that buying popular stocks is a way to investment mediocrity, or worse.

What stocks are popular today?  Dividend paying stocks.

Would I avoid them?  Not indiscriminately, but overall, yes.

Historically, dividend paying stocks have performed well for two reasons:

1.  The earnings that are paid out to shareholders are undeniably real so these businesses tend to have staying power.

2.  The relatively low price to earnings ratios typically allow for powerful dividend reinvestments over time.

Back in the day, stocks that had long histories of increasing dividend payouts were considered stocks that your grandmother would buy.  If there were investment bloggers in the 70s, 80s, and 90s, they wouldn’t have been touting dividend paying stocks (with the exception of the nifty fifty crew of the 70s).  They would have been touting growth.

And what do you know?  Dividend paying stocks generally outperformed the market.  Why?  In a nutshell, they were a better value.

But are they a better value today?  I don’t think so.

To be fair, I don’t want to indiscriminately paint all dividend paying stalwarts with the same brush.  That would be foolish.  But I don’t believe that they’re as cheap as they used to be—nor as cheap as they should be.  They have become “smart investments” because they “have performed well historically.”

I think stock pickers need to discriminate more thoroughly.  I have to admit that I’ve been nervously watching the popularity of dividend paying stocks increase, online, for the past few years.  So when I wrote my book’s chapter on purchasing individual stocks, I didn’t suggest that investors should look for stocks that “have been paying higher and higher dividends every year.”  In fact, among the main stock picking tenets mentioned in my book, I don’t mention dividends once.

Let’s take a poke at Johnson & Johnson for a moment.  I’ll admit that I used to own this stock.  But I want to add that when I bought shares in JNJ, its average PE ratio (when calculating the average earnings over the previous three years) was a lot lower than the S&P 500’s PE ratio.  I bought shares when JNJ was far less popular than it is today.  And I believe that this is a great way to make money in the stock market.  Buy a great business that isn’t popular.

Johnson & Johnson was never considered a sexy stock, so its historical PE ratios have typically lagged the PE ratio for the average S&P 500 business.

But that’s not the case today.  The S&P 500 is currently trading at a PE ratio of 13X earnings, and JNJ is trading at a PE of 15.09.  Scouring through an old Valueline Investment Survey Report, and looking back at Johnson & Johnson’s historical PE levels from 1985 to 2002, the PE ratio of the S&P 500 proves to be consistently higher than JNJ’s. 

What’s the difference today?  Popularity. 

And I see the same thing occurring with many dividend paying stocks.  Their popularity has pushed their price to earnings levels to a point where future investment profits will be jeopardized.

Buying popular stocks has never been a great strategy.  If online bloggers are practically in unison, touting high, consistent dividend paying stocks, it’s probably going to result in mediocrity for those investors.  Their stock picks will lose to the indexes.  I’m quite sure of it.

Today, my entire portfolio is indexed.  But if I had to buy an individual stock today, it would likely be a non dividend payer—or at least, not a high-dividend payer.

I would jump at Berkshire Hathaway, trading at roughly $68 per share.  It doesn’t pay a dividend.

And I would jump at another stock—one that you might not have heard of:

John Wiley & Sons.

This company has been around since the 1800s.  They publish books, journals and electronic products.  They’re actually the publisher of my book, Millionaire Teacher.

You haven’t heard of them?  Good. 

Let’s talk about growth, shall we?

John Wiley & Sons has seen its earnings per share increase by 100% in the past seven years; 200% in the past 11 years; 710% in the last 15 years; and 5,900% in the last 22 years.

Eat your heart out Johnson & Johnson.

Yeah, a boring publisher with insider ownership exceeding 80%, with decade return on total capital averaging more than 15% annually, and with… gasp, a history of paying out increasing dividends (but with much lower yields than most companies on the Dow).

But, as Buffett always asks, has each retained dollar in earnings equated to at least a dollar of market value?  The answer to that is yes.

Have a look at this long term performance chart of John Wiley & Sons stock, compared to Johnson & Johnson’s stock:

Currently, its PE ratio is roughly in line with Johnson & Johnson’s PE ratio.

But there’s a difference.

Johnson & Johnson’s earnings aren’t growing at anywhere near the rate that Wiley’s earnings are growing.

The higher the growth rate, the higher the justified PE ratio.

It’s fair to say that Wiley’s growth is making JNJ look like an ox and cart mired in the mud—and it has been making JNJ look like a mud-stuck business (in comparison) for a very long time.

I used to think the publishing business was dead.  But after looking at Wiley’s fundamental growth, I realized how wrong I was.

When my book gets published, how much will it cost Wiley to sell an electronic version of my book? 

And as an author, how much do you think I’ll get paid per book?

I’ll make roughly $1 per hard copy of each book sold.  And I’ll make roughly 50 cents for an e-book that sells for $10.

Those sort of metrics look pretty good for Wiley, don’t you think?

So… as I see it, you can follow the crowd into stocks that have grown in popularity, thanks to their long history of increasing dividend payouts, and their popular presence on investment blogs.

Or you can search a little harder to recover stocks that your neighbours (and other financial bloggers) never have on their radar screens.

If you want to do well as an individual stock picker, I think it’s a highly necessary course of action to take the road less travelled.

Don’t follow the crowd. Groupthink doesn’t work very well.