Will Dividend Stocks Survive?

Adding dividend-paying stocks to your portfolio can help you make millions in the long run. Lately, though, many investors have seen much bigger losses on their dividend stocks than they've gotten back in their quarterly checks.

When dividend investing came back into style in the years following the tech bubble, Wall Street responded with a number of exchange-traded funds designed to concentrate on stocks that paid substantial dividends. At the time, these appeared to be promising, but it wasn't clear which dividend ETF strategy would work out best. Now that some of these funds have been around for a few years, it's a good time to take a look back and see which ones have been the most successful.

Weighing yield
To distinguish themselves from their competition, dividend ETFs put together their portfolios in different ways. Let's look at some of them:

  • The WisdomTree LargeCap Dividend Index Fund (DLN) uses a simple approach, choosing the 300 largest stocks from its dividend index and weighting them by the total amount of dividends each company pays.
  • The iShares Dow Jones Select Dividend Index Fund (DVY) includes dividend-paying stocks that have maintained or increased dividends in each of the past five years, have a payout ratio of 60% or less, and trade an average of at least 200,000 shares daily.
  • The PowerShares Dividend Achievers ETF (PFM) screens for companies that have increased dividend payouts for at least 10 straight years and then chooses the highest-yielding stocks among them.
  • The SPDR S&P Dividend ETF (SDY) picks 50 high-yielding companies that have raised dividends consistently over at least a 25-year timeframe.
  • The First Trust Value Line Dividend Index Fund (FVD) uses Value Line's safety rankings to screen for stocks it deems safer than average and then takes above-average dividend yields with market caps of more than $1 billion. Unlike most other dividend ETFs, this fund gives each stock equal weight in its portfolio.

From these different approaches, you'd expect to see some wide variation in how these funds have performed. Here's a look at their recent returns:

ETF

1-Year Return

2-Year Average Annualized Return

3-Year Average Annualized Return

DLN

(20.6%)

(2.0%)

N/A

DVY

(28.7%)

(9.4%)

(5.4%)

PFM

(15.8%)

(0.5%)

N/A

SDY

(22.7%)

(5.7%)

N/A

FVD

(14.9%)

3.8%

8.0%

Source: Yahoo! Finance.

You can sum up those results with a single word: Ouch.

What happened?
Unfortunately, ETF investors who just recently jumped on the dividend bandwagon ended up investing their money at the peak for many of these funds. After years of strong performance from financial stocks, many of which pay extremely attractive dividends, the bottom fell out of the sector in 2007 and 2008. Because dividend ETFs had a lot of exposure to financials, they suffered more than the overall market did.

But stocks outside the financial sector also played a role in the bad performance of dividend ETFs. Here are some of the stocks that most of the above ETFs count among their holdings:

Stock

Current Yield

1-Year Return

2-Year Average Annualized Return

3-Year Average Annualized Return

Wells Fargo (NYSE: WFC  )

4.9%

(16.6%)

(8.4%)

0.0%

Chevron (NYSE: CVX  )

3.0%

(4.0%)

18.9%

18.2%

Kimberly-Clark (NYSE: KMB  )

4.2%

(14.6%)

(0.4%)

(1.3%)

KeyCorp (NYSE: KEY  )

6.6%

(66.7%)

(41.3%)

(27.8%)

Pfizer (NYSE: PFE  )

7.0%

(22.3%)

(8.1%)

(7.8%)

Gannett (NYSE: GCI  )

9.5%

(65.8%)

(41.3%)

(36.6%)

PPG Industries (NYSE: PPG  )

3.4%

(22.3%)

2.0%

1.0%

Source: Yahoo! Finance.

Weight matters
Making matters worse for most dividend ETFs was that they held large positions in some of the worst-performing stocks. As you can see from the stock chart above, some of the highest-yielding stocks were hit especially hard. The methods many dividend ETFs used led them to own more of those stocks and thus left the funds exposed to larger losses. Meanwhile, the First Trust ETF earned a performance advantage because its equal-weight portfolio didn't have above-average allocations to some of these big losers.

You can take two lessons from this. First, there's more to dividend investing than simply picking stocks with the highest yields. Focusing on high yields alone left investors with concentrated portfolios that were especially vulnerable to bad results in a single sector. Better-diversified fund portfolios would have helped ETF investors avoid at least some of their losses.

More importantly, though, bad results over the course of a few years don't prove that dividend stock investing is a flawed strategy. Rather, they show that even the most successful long-term strategies can produce significant losses over short periods of time. Although certain dividend stocks may fail, dividend investing as a strategy will definitely survive.

To learn more about dividend investing, read about:

Want help finding dividend stocks that will survive the bear? Our Motley Fool Income Investor service can help. To read expert advice from our top analysts, along with our current stock recommendations, try Income Investor free with a 30-day trial.

Fool contributor Dan Caplinger knows exactly how low the market needs to go before he'll add more to his stock allocations. He doesn't own shares of the companies mentioned in this article. PPG, Pfizer, and Kimberly-Clark are Motley Fool Income Investor picks. Pfizer is also a Motley Fool Inside Value recommendation. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy won't keep you waiting.


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  • Report this Comment On July 21, 2008, at 7:28 PM, Zade wrote:

    Because financial stocks are one of the main contributors to dividend investing and have been hit hard it helps explain why many of these funds (which I am sure held quite a lot of financials) have not performed well. Let's also not forget (which your article didn't highlight) that the benefits of dividends and capital investing are about to lose the tax benefit passed during the Bush administration. The liberal Congress run by Democrats will not extend those tax cuts and that factor is being priced in right now I believe.

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