In the early part of the 20th century, the only way to entice investors to buy stocks was to offer a dividend yield greater than the coupon yield on Treasury bonds and even corporate bonds. By the 1950s, though, dividend yields on the S&P 500 fell below the yield on the 10-year Treasury for the first time. By the end of the century, dividend yields on the S&P 500 were at a historic low, with fewer than half of the stocks in the S&P 500 showing any yield at all.

However, some industry groups still have substantial yields, including utilities, energy companies and real estate investment trusts. At my shop, we tend to avoid utility companies for two reasons -- one, they're subject to too much government regulation, and two, the dividends often have poor earnings coverage and are, therefore, likely to get cut. For example, the dividend yield on Pacific Gas & Electric is 7.5%, but the earnings are currently negative, so there's no dividend coverage at all.

We do own energy pass-through partnerships like Suburban Propane(SPH:NYSE) with a current dividend yield of 8.26%, and diversified oil producers like Exxon Mobil(XOM:NYSE), which yields 2.23%. We also own REITs, including Crescent Real Estate(CEI:NYSE), with a yield of 8.93%, and BRE Properties(BRE:NYSE), which yields 5.91%.

Up to 25% of our portfolios include these "slow but steady" companies. In bull markets, we will pick up 7%-12% a year in total return (appreciation plus yield) from these stocks. Even in bear markets, the total return still tends to be positive, offsetting losses from our more aggressive stocks and anchoring the overall portfolio. You can check a company's dividend yield and payout ratio by clicking on the Key Stats/Ratios tab of a company on TheStreet.com; for example BRE Properties.

Operating Cash Flow

I wrote about how to read a statement of cash flow some time ago. Along with the income statement and the balance sheet, the statement of cash flow is one of the three fundamental accounting reports to monitor the health of a company. The statement of cash flow is divided into cash from operations, cash from investments and cash from financing. In my experience, a company with negative cash flow from operations is significantly riskier than a company with positive cash flow, because the company with negative cash flow is running down its cash reserves and is forced to go back to Wall Street periodically, whether in the form of bank financing, debt or equity issuance. In the current environment, negative operating cash flow could well mean death.

Here is the statement of cash flows (annual) for priceline(PCLN:Nasdaq). The numbers are negative virtually for the life of the corporation, although the most recent quarterly report shows the loss at just $6.3 million/quarter. With $124 million in cash on hand (from the most recent balance sheet), priceline will probably survive.

Microsoft(MSFT:Nasdaq), which generated $14 billion in operating cash flow last year, could buy priceline (market cap $350 million) and quite a few other Internet service companies were it not for obvious regulatory problems.

Wal-Mart(WMT:NYSE) generated $9.6 billion in cash, invested $8.7 billion back in the business, paid $1 billion in dividends and raised $628 million in issued stock, debt and other financing activities for a net gain of $198 million in cash. These are the kinds of numbers we like to see!

360networks(TSIXQ:OTC BB) generated an operating loss of $46 million in its last report and obviously failed to cover interest payments on several billion dollars of long-term debt. Even though this company successfully completed most of its fiber-optic network, worldwide capacity far outstripped demand and revenue was sharply lower than expected. 360networks filed for bankruptcy last month as it, along with many other companies, simply ran out of gas.

Out of the 250 companies in our portfolios, we're willing to risk owning only a handful with negative operating cash. This discipline kept us out of a lot of trouble last year.

Beta

Beta is a measure of correlation between a stock price and the overall price level of the stock market (usually defined as the S&P 500). A company with a beta of 1.15 will tend to move, for example, 15% more than the overall stock market moves on both the upside and downside. A company with a beta of zero will move independently of the stock market, while a company with a negative beta (or a short position with a positive beta) will move in the opposite direction as the market. Betas can be obtained from the Key Stats/Ratios tab at TheStreet.com.

Here are the betas of some common stocks and indices:

Company	Beta	Comments
SPDRS (SPY: Amex)	1.00	Perfect correlation because same components
Nasdaq 100 (QQQ: Amex)	1.60	Much faster on the upside, much faster on the downside
Cisco (CSCO: Nasdaq)	1.83	Typical "growth" stock
Emerson Electric (EMR: NYSE)	0.73	Typical "value" stock
priceline (PCLN: Nasdaq)	4.34	Aggressive growth company
General Electric (GE: NYSE)	1.19	Stock market proxy
Suburban Propane (SPH: NYSE)	0.06	High dividend, slow but steady
BRE Properties (BRE: NYSE)	-0.01	High dividend, slow but steady
Southern Company (SO: NYSE)	-0.36	Only a handful of companies with negative betas, mostly utilities, because safe-haven cash flows into these stocks during bear markets
Source: Market Guide

The only way to realistically create a zero-beta portfolio is to go long and short stocks (and stock indices). However, by mixing low-beta stocks with our high-beta stocks, we can bring the beta of our clients' portfolios close to the overall market, even if 75% of the stocks we invest in are higher-beta growth companies. Many investors in 1999 mistook their high-beta portfolios for genius, only to get squashed in 2000.

Implied and Historic Volatility

Volatility is an estimate of the likely range of returns of a stock or index over the next year. Historic volatility is derived from the standard deviation of annualized actual returns, typically over the last 30 days. Assets with larger daily price swings generate larger historic volatilities.

Implied volatility is derived from the pricing of put and call options on the underlying security. All other things being equal, higher-priced options generate higher implied volatility.

Here's how to interpret these numbers: The VIX (which is the implied volatility derived from the S&P 100 index) is currently 23.2. Over the next year, then, there is a 67% chance that the index will rise or fall by 23.2% (in statistics, approximately 67% of returns are likely to be within the first standard deviation -- in this case, between negative 23.2% and positive 23.2% -- while 96% of returns are likely to be within two standard deviations, in this case between negative 46.4% and positive 46.4%).

Historical volatility is interesting, but implied volatility can communicate more useful information because it is derived from option market makers' expectations of the future. For example, the implied volatility of a stock may suddenly rally compared with its historic volatility; later, it might be learned that the company is the subject of a takeover bid.

IVolatility has a free public area for looking up historic and implied volatility. Indices generally have lower volatilities than individual stocks because random movements of the components cancel each other. The table below shows the average of implied volatility from puts and calls on the underlying security, except in the case of Suburban Propane and BRE Properties, where historic volatility is used because no options are traded on these stocks.

Company	Volatility	Comments
Volatility Index (VIX)	23.2	S&P 100 stocks
Nasdaq VIX (VIXN)	47.5	Nasdaq 100 stocks
Cisco (CSCO: Nasdaq)	54.6	Typical "growth" stock
Emerson Electric (EMR: NYSE)	32.6	Typical "value" stock
priceline (PCLN: Nasdaq)	97.5	Aggressive growth company
General Electric (GE: NYSE)	31.4	Stock market proxy
Suburban Propane (SPH: NYSE)	22.1	High dividend, slow but steady
BRE Properties (BRE: NYSE)	13.3	High dividend, slow but steady
Southern Company (SO: NYSE)	22.0	Utility company
Source: IVolatility

The VIXN, which contains many aggressive growth stocks, is twice as volatile as the VIX. priceline is twice as volatile as Cisco(CSCO:Nasdaq) and eight times as volatile as BRE Properties. In a bull market, high-volatility stocks generally work in your favor (i.e., they move up faster than the overall market). In a bear market, though, high-volatility stocks can destroy your equity. In our experience, stocks with volatilities of twice the overall market require extra attention.

(Note: It's not meaningful to compute weighted averages of volatilities. There are software packages that can simulate the volatility of a portfolio of stocks given the volatility of its components, but that's beyond the scope of this column.)

Homework

Assuming you have symbols and current market values in an accessible format, create an Excel spreadsheet that enables you to compute the weighted average dividend and betas of the stocks in your portfolios (see example below). If the weighted average dividend yield is 0.5% or less, consider buying some dividend-oriented stocks such as REITs or energy producers.

Put an X next to every stock with negative operating cash, another X for every stock with volatility more than two times that of the overall market (i.e., the VIX). If one-quarter of your stocks have at least one X, consider paring back some of these more aggressive positions.

A Sample Risk Assessment
Company	Current Market Value	Dividend Yield	Coverage	Beta	Volatility	2x VIX	Negative Operating Cash Flow	% of Portfolio	Dividend Weighting	Beta Weighting
Cisco (CSCO:Nasdaq)	$20,000	0.00%		1.83	54.6%	X		28.8%	0.00%	0.53
Emerson Electric (EMR: NYSE)	10,000	2.69	45.37	0.73	32.6			14.4	0.39	0.11
priceline (PCLN: Nasdaq)	2,000	0.00		4.34	97.5	X	X	2.9	0.00	0.12
General Electric (GE: NYSE)	10,000	1.50	44.75	1.19	31.4			14.4	0.22	0.17
Suburban Propane (SPH: NYSE)	5,000	8.26	96.46	0.06	22.1			7.2	0.59	0.00
BRE Properties (BRE: NYSE)	7,500	5.91	227.91	-0.01	13.3			10.8	0.64	0.00
Southern Company (SO: NYSE)	15,000	5.79	NM	-0.36	22.0			21.6	1.25	-0.08
Totals	$69,500	3.08%		0.85					3.08%	0.85
	VIX: 23.2% S&P 500 Yield: 1.30% S&P 500 Beta: 1.00
Sources: IVolatility, Market Guide

David Edwards is a portfolio manager and president of Heron Capital Management, a New York management firm, which is consistently ranked among the top 20 in its category by the Nelson's "World's Best Money Managers" survey. At the time of publication, his firm was long Suburban Propane, ExxonMobil, Crescent Real Estate, BRE Properties, Microsoft, Walmart, 360networks, Cisco, Emerson Electric and General Electric, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Edwards appreciates your feedback and invites you to send it to David Edwards.