How to Earn More From Your Investments

An entire generation of investors grew up on the notion that you invested in stocks for long-term growth. If you wanted income, you looked to bonds, CDs, or other "safe" investments.

Yet that logic got turned on its face yesterday. For the first time in 50 years, the dividend yield on the S&P 500 was higher than the yield on the 10-year Treasury note, according to Bloomberg. The yield on S&P 500 is around 3.5%. As you can see in the table below, you don't have to look at the most troubled sectors of the economy to find healthy dividend payouts.

Stock

Dividend Yield

McDonald's (NYSE: MCD  )

3.6%

Kimberly Clark (NYSE: KMB  )

4.1%

Emerson Electric (NYSE: EMR  )

4.2%

Chevron (NYSE: CVX  )

3.7%

Kraft Foods (NYSE: KFT  )

4.3%

Coca-Cola (NYSE: KO  )

3.6%

Source: Yahoo! Finance as of close on Nov. 19.

Depending on how you interpret dividend stocks passing up bonds on a yield basis, the milestone could have disturbing implications for the stock market -- or it could represent the opportunity of a lifetime for investors in dividend-paying stocks.

What yields mean
Rising dividend yields on stocks support the idea that the economy's slowdown is more than just a short-term phenomenon. Normally, when the economy is growing, it tends to boost share prices gradually over time. As investors become accustomed to seeing that steady growth, they demand less in dividend payments to compensate them for the added risk of investing in stocks.

Now, though, with the Federal Reserve predicting an imminent recession that could be long and painfully drawn out, stock investors are no longer counting on seeing the growth that produces capital appreciation. Instead, they want the certainty that dividend payments provide -- of all the accounting tricks that companies can use in reporting financial results, the one thing you know simply can't lie is a quarterly dividend check in your hand.

Demanding dividends
With the vast majority of stocks having suffered big losses this year, investors have hoped for a turnaround for months. Yet as the downturn continues, many are giving up on the idea of a quick rebound, instead looking for other signs that a stock could help them make larger profits over the long term.

With dividend-paying stocks, you don't necessarily need to see your shares go up in value to make money. With stocks beating out bonds on the income-paying scale, just breaking even with your shares means you're doing better overall. Any price appreciation you may get is just icing on the cake.

In contrast, former high-growth superstars that don't pay dividends, such as Research In Motion (Nasdaq: RIMM  ) , may suddenly find themselves less attractive to investors in a recession. Especially if the credit crunch continues, the cash-generating discipline that companies have to have in order to make regular dividend payments could prove the most important trait shareholders look for in investing their money.

Just watch out
In looking through the many dividend-paying stocks available, be on the lookout for some early warning signs that may indicate potential trouble. Here are some examples:

  • Borrowing to pay dividends. Ideally, the cash to pay dividends comes from a company's natural cash flow. Therefore, if you see debt levels on a dividend stock rising, that's a sign that a dividend may be unsustainable.
  • Yields that are too good to be true. Double-digit yields may look attractive, but often they result from one-time anomalies. Don't count on those high yields lasting long unless you do thorough research to understand why they're so high -- and even then, don't let up your guard even if you decide to buy shares.
  • Special situations. Especially with certain types of investments, such as REITs, tax laws may require high dividend payments that are tied to income. So if the recession leads to cuts in future income, you can't rely on ever seeing those high dividends again.

If you're careful, though, picking dividend-paying stocks can be a great way to protect yourself from the worst of the stock market's volatility while also giving you a cash cushion to help you get through lean times.

For more on making the right moves in your portfolio, read about:

To get the latest on which dividend-paying stocks are best for your portfolio, check out our Motley Fool Income Investor newsletter. Each month, you'll get our most up-to-date recommendations, along with other useful information you need to be informed on income investments. Best of all, you can take a look absolutely free with a 30-day trial.

Fool contributor Dan Caplinger is counting his dividends, even as many of his stocks continue to drop. He doesn't own shares of the companies mentioned in this article. Kimberly Clark and Kraft Foods are Motley Fool Income Investor picks. Coca-Cola is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy pays dividends.


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