How to Shoot Dividend Ducks in a Barrel

I love it when the market is wrong, because it means a better buying opportunity for me. It could mean one for you, too.

These days, the very word "securitization" has been vilified. Reality check: Stocks are simply securitized companies. Similarly, there's nothing wrong with a subprime loan if the price is right (and it wasn't, in many cases).

Has your portfolio been volatile? Do you genuinely believe that the volatility has been directly related to market-moving fundamentals? In some cases it has been, but there's a lot of panic going on, folks, and we all know it.

One area hit hard has been dividend stocks. I like to root for the misunderstood underdog -- especially when that underdog is the secret favorite.

Dividend stocks are ducks in a barrel
Dividend stocks, which do feel the bite of inflation more than most, have a reputation for being stodgy and low-growing. Guess what? That's wrong. A recent study by Rob Arnott and Cliff Asness grouped stocks by yield and found, amazingly, that the highest-yielding bracket had the highest earnings growth over the next decade!

And it's not just a matter of earnings growth. I like dividend stocks because they win the returns war, too. Ned Davis Research looked at S&P 500 dividend payers and non-payers from 1972 (when the U.S. abandoned the gold standard) to 2006. Stocks that didn't pay dividends returned 4.1% annually. Stocks that did returned 10.1% annually -- six percentage points more per year! Dividend stocks are a smart way to invest -- the smartest way for most investors, if you ask me.

Investing isn't just about academic studies. You probably value a few other factors, too. One is that you get a portion of your return in cash, which gives you an option to spend it, save it, or reinvest it -- while minimizing risk. Those steady payouts help take the bite out of market gyrations. Moreover, dividend stocks beat the market with less volatility. Isn't beating the market what we're all after in the end?

Six stocks to get you started
To give you some starting ideas for dividend stocks, I used an institutional-software package called Capital IQ to screen for stocks with enterprise values higher than $1 billion, yielding more than 2.5%, and paying out less than 85% of their free cash flow -- the latter being a metric I like to use in Income Investor when calculating payout ratio, because it's more accurate.

Here are the results -- they're not official recommendations, mind you, but interesting stocks for further research nevertheless:

Data from Capital IQ, a division of Standard & Poor's, and adr.com.

I believe that our troubled economy is, and will be, presenting some great buying opportunities. I see no need to rush. It's more important to be in the best companies -- the ones that survive the downturns best, and come out even stronger, often after outlasting or simply buying out some of their competition.

If you'd like to go beyond this point (and I'm guessing you will, if you're a serious investor), I invite you to grab a free guest pass to Income Investor. It's beating the market by 7 percentage points and has more than 70 actively tracked recommendations for you to choose from. You can grab that guest pass right here.

This article was first published Feb. 5, 2008. It has been updated.

James Early owns no stocks mentioned in this article. Thompson Reuters is an Inside Value selection. Autoliv is a Global Gains recommendation. The Motley Fool has a disclosure policy.