By Rex Moore, The Motley Fool
The power of dividend investing is pretty well known these days. Higher-yielding stocks tend to offer higher returns over time than low- or no-yield stocks do, according to research from Jeremy Siegel and others. In fact, the 20 best-performing survivor stocks from the original S&P 500 in 1957 are all dividend payers.
What's more, reinvesting dividends acts as a "bear-market protector and return accelerator," according to Siegel. The extra shares purchased and accumulated at higher dividend yields during down periods act as a protector in falling markets, and these extra shares turn into a "return accelerator" when prices rise.
As the recent economic crisis illustrated all too well, however, you can't buy just any high-yielding stock. Dividends that get cut or suspended entirely can wreak havoc on a stock price -- and thus, your portfolio.
Fortunately, there are steps you can take to lessen your chances of buying one of these train wrecks. James Early, advisor of our Motley Fool Income Investor service, suggests looking at the payout ratio, for starters. That's simply the percentage of net income a company uses to pay its dividend. Obviously, the higher the payout ratio, the tougher it is for a company to meet its dividend obligation. James looks for a payout ratio less than 80% for safer companies and a sub-60% or even sub-50% payout for risky companies.
To further stack the odds on your side, you can limit your search to companies that have grown their dividend over the past three years or so. That eliminates the less stable or erratic dividend payers.
I constructed a screen to find some promising high-yield, low-risk utilities for further research. I made sure the stocks met the following criteria:
Market cap > $1 billion.
Payout ratio < 60%.
Three-year dividend growth > 0%.
Utilities sector, as defined by Capital IQ.
Here are the top 10 highest yielders the screen produced:
AGL Resources (AGL)
Public Service Enterprise Group
Dominion Resources (D)
CMS Energy (CMS)
Source: Capital IQ, a division of Standard and Poor's.
These stocks are great places to start your research, but they're not formal recommendations. You can add any companies you're interested in following to your own personal watchlist.
What This Means
Siegel sums it up nicely in his book, The Future for Investors: "Bear markets are not only painful episodes that investors must endure, but also an integral reason why investors who reinvest dividends experience sharply higher returns."
Whether in bear or bull markets, there's a reason the top-performing stocks over the decades are all dividend payers. If you're lacking that type of exposure in your portfolio, you should take the first steps now toward finding stable dividend payers designed to weather any market cycle.
Fool analyst Rex Moore is now available in Blu-ray. Exelon is a Motley Fool Inside Value pick. AGL Resources and Dominion Resources are Motley Fool Income Investor picks. Motley Fool Options has recommended a covered strangle position on Exelon. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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