Why You Can't Afford to Miss These Stocks

Tell me if this sounds like you:

• You're freaking out at least a little because your investments have sunk 30% to 50% -- or more -- over the past year or so. (The S&P 500 has been down some 30% over that time frame!)
• You're worried that your retirement may end up in ugly shape.
• You're not sure that you're invested in the most effective stocks, bonds, or mutual funds.

These are not insignificant predicaments, but don't worry, I have some good news for you. You may be able to vastly improve the trajectory of your portfolio by investing in a particular kind of stock: the kind that pays out solid and growing dividends.

Why dividends rule
By now, I hope no one perceives dividends as sleepy little components of even sleepier big stocks. If you do, well, let me convince you otherwise: There are lots of reasons to love dividends.

1. Cash consistency
For starters, dividends are generally paid to you regardless of how the underlying stock (or overall stock market) is performing. Think back to the ugly year that was 2008. Even through all that market carnage, most companies still kept paying out their dividends. Many even raised them.

ConocoPhillips, for instance, is down roughly 50% over the past year, but it's been paying out $0.47 per share every quarter for more than a year -- a rate that's actually 15% higher than its prior dividend amount. Meanwhile, Altria is down more than 10% over the past year, but has consistently paid cash dividends to shareholders; the company is yielding 7.7%!

2. Efficiency, stability
Next, dividends should be attractive, because they tend to be attached to relatively stable companies. Now, that might seem strange, given that well-publicized failures Bear Stearns and Lehman Brothers were both dividend payers ... or because many "efficient, stable" dividend payers nonetheless lost 30% or 50% of their value last year.

While those are glaring examples, I believe they are exceptions. James Early, the advisor for our Motley Fool Income Investor service, recently cited an academic study with powerful conclusions:

[The study found that] earnings growth increased with dividend payout, right up to the highest payers having the highest next-10-year earnings growth. Scratching your head? So were many investors. Traditional wisdom was that companies paid dividends when they didn't have growth opportunities, not the other way around. But dividends can signal corporate health and force managers to allocate capital efficiently. (Emphasis added.)

Though there are always exceptions and occasional blowups, like those in the financial sector, it's kind of a given that a dividend will belong to a relatively stable company. After all, a company's management has to be pretty certain they can reliably pay out a dividend from their earnings before they commit to the payout to begin with.

Finally, it's important to pause and reflect on the difference between a stock's price and its value. If your stock has taken a 30% haircut over the past year, has the underlying value of the company lost 30%? Think of Coca-Cola, for example. Its stock has spent several years languishing (it beat the market last year but still fell), but throughout those periods, it has still been selling billions of servings of beverages in more and more places. It has grown more valuable, and has kept paying out (and increasing) its dividend over time.

3. Cash today, more cash tomorrow ...
Dividends are also wonderful because they grow -- ideally along with the share price, giving you a one-two punch. Check out the growth rates of these companies:

Source: MSN Money. Note: Garmin pays its dividend once per year.

You're not likely to see any company maintain growth rates of 30% over 20 years, but there are plenty of firms that have kept up 10%-plus rates for long periods. Imagine that you spend $10,000 on a stock that pays you a 4% dividend, or $400. If that dividend is hiked by an annual average of 12% (lower than the companies above), it will become more than $3,800 in 20 years.

One key, though, is to reinvest those dividends until you need the income -- which leads to the fourth and final point:

4. Outsmart your retirement nest egg
It's generally advised that to make your nest egg last for most or all of your retirement, you should withdraw no more than 4% of it each year (adjusting that along with inflation).

Well, if you're heavily invested in dividend payers, and they pay you an average 4% per year, you may not end up taking anything from your principal at all, giving you more of a safety cushion and more to leave your heirs. Better still, over time, your effective yield will likely surpass 4%. A high-yield portfolio can do wonders for your future.

Don't just take my word for it, though:

• As my Foolish colleague Ilan Moscovitz has noted, "According to research from professors Fuller and Goldstein, from 1970 to 2000, dividend-paying stocks outperformed non-dividend payers during down markets by an average of 1.5% per month!"
• Fellow Fool Shannon Zimmerman also noted: "Between January 1926 and December 2006, 41% of the S&P 500's total return sprang not from the price appreciation of the stocks in the index but from the dividends its companies paid out."

The best news of all
Given our struggling economy, this is a particularly attractive time in which to buy dividend payers. Companies you may have wanted to own anyway are now trading for less than they were a year or two ago -- and have fatter yields to boot.

Add it all up, and that's why you can't afford to miss these stocks right now.

So go ahead and find some great growers on your own, or let us help you. We'd love to introduce you to many promising dividend payers via our Income Investor service, which you can try free for 30 days. On average, its picks are beating the market handily and boast an average dividend yield of more than 5%. Click here to learn more.

This article was originally published on April 2, 2009. It has been updated.

Longtime Fool contributor Selena Maranjian owns shares of Paychex, Home Depot, and Coca-Cola. Home Depot, Coca-Cola, and Paychex are Motley Fool Inside Value recommendations. Coca-Cola and Paychex are Motley Fool Income Investor selections. Garmin is a Motley Fool Global Gains recommendation. The Motley Fool is Fools writing for Fools.