Investing in Dividend-Paying Stocks
by Alexander Green, Investment U's Chief Investment Strategist
Monday, September 26, 2011: Issue #1608
Albert Einstein wasn't famous as an investor. He was a genius who revolutionized theoretical physics. But if he were alive today, it's pretty clear what he would be doing with his money. And you should be doing it, too.
Let me explain...
It's a truism that when times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
This is exactly the opposite of what they should be doing, of course.
But today you have a great opportunity to both limit risk and generate superb returns in your stock portfolio with - stifle that yawn - stodgy, old dividend-paying stocks. These investments aren't nearly as boring as you may think. And in the decade ahead, their returns are likely to be outstanding.
The Basics of Dividend-Paying Stocks
Let's start with the basics. Dividend yields are a company's annualized payment divided by its share price. When share prices fall - as they have over the last few months - yields rise. In fact, stocks have fallen so far - and bonds have risen so much - that the Dow currently yields 30 percent more than 10-year Treasuries.
It still astonishes me that investors are willing to lend money to the U.S. Treasury for the next 10 years at less than two percent. What a terrible bet, one that virtually guarantees a negative, real (i.e. after inflation) return over the next decade.
A far better bet is a diversified portfolio of dividend-paying stocks. Understand that, over the long run, stock market performance is tied to economic growth. And - news flash - the growth outlook in the developed world today isn't exactly torrid.
Understand furthermore that over the eight decades through 2010, dividends contributed 44 percent of the stock market's return, according to Fidelity Investments. Sometimes it was much more. During the 1970s, for example, dividends generated 71 percent of returns.
Dividend stocks today represent an unusual opportunity. U.S. corporations are sitting on $2 trillion in cash, a record amount. More S&P 500 companies have initiated or raised dividends this year through August than during the same period in any of the last seven years. And there's plenty of room for more increases. Payments are less than one third of profits, a historic low.
If you're a growth-oriented investor, you probably don't think much about dividends. You're interested in doubling or tripling your money. And with a bit of patience, you can.
The Historical Returns of Dividend-Paying Stocks
Analysts often talk about the lost decade, how stocks have essentially returned nothing since the market highs in the spring of 2000. But the story has been very different with dividend-paying stocks.
Over the past decade - with dividends reinvested:
- Oil producer Chevron Corp. has returned 200 percent.
- Altria Group, the U.S. tobacco giant, has returned more than 300 percent.
- Even musty old Con Edison - a utility that was born 23 years before Thomas Edison - has returned 130 percent over the period.
Today there are plenty of blue-chip stocks with decent (and growing) dividends attached. Consider Johnson & Johnson, Procter & Gamble, Exxon Mobil, AT&T, Merck, or Verizon.
Or, for a more diversified approach, plunk for a few shares of PowerShares Dividend Achievers Portfolio (NYSE: PFM), the Vanguard High Dividend Yield ETF (NYSE: VYM), or the WisdomTree Total Dividend Fund (NYSE: DTD).
Dividend stocks alone won't generate a mouth-watering return. But dividends will rise over time - and surprising things happen when you reinvest them. Picture a snowball rolling down hill.
Albert Einstein understood this. As he observed, money compounding "is the most powerful force in the universe."