Frightening News About Dividend Stocks

For dividend lovers, 2008 and its aftermath were brutal.

Dividend cuts were announced at the fastest pace in more than 50 years. Check out some of the companies that cut their dividends substantially in the past year or two:

Those aren't even modest little trims. They're whoppers. And for some of these companies, cuts like this haven't happened in a long time. In its 112-year history, Dow Chemical, for example, had never cut its dividend. For General Electric, you'd have to go back 71 years to find the most recent reduction.

The news gets even scarier. Ned Davis Research assessed S&P 500 stock returns from January 1972 to April 2009, based on companies' dividend policies:

Monthly data, Jan. 31, 1972, to April 30, 2009. Copyright 2009 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All rights reserved.

That data may frighten investors who've just watched blue chips such as GE and Dow Chemical reduce their payouts to shareholders. Let's examine the implications:

• S&P 500 companies that cut or eliminated their dividends are dead last in terms of total returns. So you'll want to avoid dividend blowups; to do so, be extra mindful of high payout ratios, companies with industry headwinds, and dividend payers with iffy track records.
• Non-dividend payers weren't all that much better: They turned $100 into just $129 over that time frame.
• By a substantial margin, dividend growers or initiators were the best in breed among S&P 500 stocks.

Are 37 years not enough for you? In "The Secret of Dividends," my colleague Shannon Zimmerman explained that between January 1926 and December 2006, "41% of the S&P 500's total return was due not to the price appreciation of the stocks in the index, but to the dividends its companies paid out."

What to do
Clearly, dividends cut both ways. The lesson, then, is to focus on companies that have a history of increasing their dividends. Here's a way to start doing just that.

1. Look for overachievers. You can find such companies through the Dividend Achiever index, which features companies that have upped their dividends for at least 10 years in a row.

2. Screen. The Dividend Achievers list features more than 275 U.S. companies, so you'll then want to narrow down your search. Here are some companies that meet the following screening criteria:

• They are each Dividend Achievers.
• They have at least a three-star rating from our Motley Fool CAPS community.
• They have increased their payouts by at least 10% per year for the past five years.

Sources: Indxis, Motley Fool CAPS, and MSN Money.

3. See our favorite stocks. We'd love to introduce you to many promising dividend payers in our Income Investor service, which you can try for free. On average, its picks are beating the market handily and boast an average dividend yield of 5.5%. Click here to learn more about a 30-day trial.

Last lessons
Finally, a glance at the returns of non-dividend payers should drive home how much your portfolio might suffer if it doesn't have some solid dividend payers in it. Note, after all, how close the returns are for dividend cutters and non-payers. There have been time periods in which dividend cutters still came out ahead of non-payers. Ignore the awesome power of dividends at your own portfolio's peril.

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This article was originally published on May 19, 2009. It has been updated.

Longtime Fool contributor Selena Maranjian owns shares of General Electric and Procter & Gamble. Lowe's Companies, Stryker, and Vulcan Materials are Inside Value picks. Procter & Gamble is an Income Investor selection. The Fool owns shares of Procter & Gamble. The Motley Fool is Fools writing for Fools.