Don't Cut This Dividend!

Ahhhh, dividends. The spice of the investing life. Dividend investing can make you money.

From 1972-2006, Ned Davis Research found that S&P 500 dividend stocks beat index non-payers by six percentage points annually.

Moreover, ING Investment Management noted that dividends constitute a third of all S&P 500 gains since 1926. More amazingly, from 1985-2000 -- the technological wonder years -- the performance advantage of dividend-paying stocks actually widened!

Dividend and conquer
Dividends outperform, with the added advantage of choice. You can take the cash or reinvest it, and either way, you win. That's why I pursue great dividend stocks in my Motley Fool Income Investor service. I've singled out six interesting dividend stocks for you below.

But dividends aren't perfect. If you want to feel like an investing loser, buy a stock shortly before it cuts its dividend.

For instance, following "restructuring" in 2001, Xerox surprised investors by eliminating its payout -- not what shareholders had come to expect from a one-time stalwart.

To be fair, Xerox didn't want to be another Woolworth -- an erstwhile iconic brand (the Woolworth headquarters was once the world's tallest building) -- that doggedly paid out everything it had to maintain its dividend. Also, Woolworth eventually went under, while Xerox recently restarted its dividend program.

Still, if you build a proper dividend fortress, you don't have to worry about dividend cuts -- ever.

You don't have to lie there, helpless
That's not to say a dividend-payer of yours will never cut its dividend. Instead, if you have a diversified dividend portfolio with quality companies that tend to hike their payouts, you needn't fear dividend cuts for these three reasons:

  1. The best direct insurance against a payout cut in one of your stocks is having several others that are raising their payouts at the same time. (At Income Investor, we love -- and look for -- payout-hiking stocks.)
  2. Good companies seldom have to cut their dividends in the first place. Pick well off the bat, and you won't have to worry. (More on this in a moment.)
  3. A properly diversified portfolio of foreign stocks can be a great ticket to dividend growth. Unlike American companies, foreign companies tend to pay a set percentage of earnings, versus a fixed "dollar" amount. This means more variability, but it also means that foreign companies can be more willing to raise their payouts.

(Wall) Street smarts
In my Income Investor service, I advocate holding a diversified basket of top-notch dividend investments. Academic evidence shows that dividend stocks are investments for the thinking man or woman (because they outperform with less risk), and the smart way to invest is to hold a bunch of them.

To quickly find stocks that may be on thin payout ice, look at the "payout ratio" -- dividends paid as a percentage of earnings. For Income Investor, I take that metric a step further, because accounting standards have made "earnings" a fuzzy little number. That's why I prefer to compare dividends paid to free cash flow.

To find you some interesting dividend stocks -- approaching the kind of stocks I seek out for Income Investor subscribers -- I used Capital IQ, an institutional software package, and screened for stocks with ample free cash flow in proportion to their dividends. Here are the results:

Company

Yield

Market Cap (billions)

FCF Payout Ratio

Caterpillar (NYSE: CAT  )

2.2%

$41

22%

ConocoPhillips (NYSE: COP  )

2.1%

$123

23%

Pfizer (NYSE: PFE  )

5.4%

$160

52%

Procter & Gamble (NYSE: PG  )

2.0%

$214

79%

AT&T (NYSE: T  )

4.2%

$230

49%

Verizon (NYSE: VZ  )

4.0%

$122

69%

Intel (Nasdaq: INTC  )

2.3%

$116

57%

Data from Capital IQ.

A happy ending for you
While those aren't formal recommendations, they should help jump-start your research. Better yet, if you like the idea of a secure dividend or a whole quiver of stocks designed to give you a steady payout, I invite you to take a free look at Income Investor.

We have more than 70 recommendations that are collectively beating the S&P 500 by seven percentage points on average. You can try them out with a 30-day trial.

James Early owns no stocks mentioned in this article. Pfizer and Intel are Inside Value recommendations. The Motley Fool has a disclosure policy.


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