The New Dividend Era

These are bad times to be in the market. The S&P 500 is down almost 12% year to date. In the last 10 years, the market has averaged a mere 2.9% annual return; calculated since 2000, that return drops to roughly 0%.

The market looks no more certain from this point onward. When will the economy rebound? How strong will the recovery be? What will the next president do? No one knows. It's quite possible that the market will return nothing for years to come.

What can you do?
You can just get out of the market. However, safer investments aren't even keeping up with inflation these days. Meanwhile, the need to earn a decent return on our money keeps increasing, as the price tags for college and retirement climb ever higher. Is there any silver lining to this dark cloud?

One, perhaps. Dividends have accounted for more than 41% of the market's total return from 1926 until the end of 2007. Lately, as market returns fall below historical averages, dividends have accounted for an even greater share of return.

What can dividends do for you?
First, they can pay you a decent return on your initial investment. That return is taxed at no more than 15%, giving dividends a huge tax advantage over other investments. Second, as companies grow earnings, your payout percentage and return can greatly increase over time, unlike bonds that simply pay a fixed rate. Finally, owning dividend stocks positions you to participate in eventual market upswings.

To succeed with this approach, however, you must find companies with secure and growing dividends. It defeats the purpose if, like Citigroup (NYSE: C  ) or a Wachovia (NYSE: WB  ) , a company slashes its dividend multiple times while its stock plummets.

Motley Fool CAPS is an excellent place to search for worthy dividend players. Stocks earning five-star ratings from the 115,000-member CAPS community have posted stellar performance on average, far outpacing the market. In an attempt to find stocks with reliable and growing dividends, we'll use CAPS to screen for the following criteria:

  • A market cap of $10 billion (large enough to ride out a tough economy).
  • A dividend of at least 3.5% (a nice yield).
  • A long-term debt-to-equity ratio below 0.60 (a stable balance sheet).
  • An EPS growth rate of at least 10% (a growing business).
  • Return on equity of at least 20% (an efficiently run operation).

Company

CAPS Rating

Market Cap

LT Debt to Equity

Current Dividend Yield

EPS Growth (3 years)

Return on Equity

DuPont (NYSE: DD  )

*****

39.7 B

.42

3.7

14.1

26.4

FranceTelecom (NYSE: FTE  )

*****

82.06 B

0

6.0

24.93

21.1

Telkom Indonesia (NYSE: TLK  )

*****

16.7 B

.21

4.9

29.41

35.5

Southern Copper (NYSE: PCU  )

*****

22.2 B

.32

9.1

15.55

50.7

Bank of Nova Scotia (NYSE: BNS  )

*****

48.48B

.22

3.9

16.68

20.9

Source: Motley Fool CAPS as of Aug. 8, 2008.

These companies are not recommendations -- just an invitation to do further research.

Collectively, these stocks yield an average of more than 5.5%. Other worthy dividend stocks can generate a similar yield. All by itself, this is a decent return on your money. But earning this return while simultaneously positioning yourself to benefit from an eventual market upswing is a beautiful strategy indeed.

Performance during tough markets can be a huge factor in determining the long-term quality of our investments. Wise decisions that enable us to make money and stay in the market during turbulent times are just as important to long-term results as hitting multibaggers during booming markets.

What do you think about dividend stocks? Speak your mind on Motley Fool CAPS. More than 115,000 investors are waiting to hear what you have to say. CAPS is 100% free, so simply click here to get started.

FranceTelecom, Telkom Indonesia, and The Bank of Nova Scotia are Motley Fool Income Investor recommendations. Telkom Indonesia is a Motley Fool Global Gains pick. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tom Hutchinson holds shares in DuPont. The Motley Fool has a disclosure policy


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