What Dividend Stocks Can't Do

As the stock market continues to get more and more edgy, investors are starting to look for shelter from the coming storm. Although dividend stocks become even more attractive as stock prices fall, you need to understand going in that even stocks that make excellent long-term investments won't necessarily keep you from suffering short-term losses.

A schizophrenic market
Right now, the stock market is telling two different stories. When you look at the recent correction, it's clear that there's a lot of uncertainty about what's in store for the economy and the business environment going forward. The year-long rally has built up some big expectations, and some now wonder if there's any chance that reality will be able to match up with the rosy scenarios that the S&P 500's 80% advance seemed to foretell.

On the other hand, when you look at dividend payments, that rosy scenario still seems to be playing itself out. Yesterday, FedEx (NYSE: FDX  ) became the latest major company to raise its dividend, hiking its quarterly payout by 9%. Although a 0.6% dividend yield is pretty stingy compared to many companies, FedEx has doubled its dividend over the past six years, despite having lost money over the past 12 months.

Stocks heading lower
Unfortunately, paying a dividend doesn't make a stock invulnerable to falling markets. FedEx fell 3.6% yesterday despite its announcement, bringing its total loss since April 15 to 20%.

Even high-yielding stocks haven't sheltered shareholders from the storm. Take a look at the telecom sector, which features several companies that don't have incredibly strong prospects, but do have impressive cash flows. But since their April highs, AT&T (NYSE: T  ) has fallen 9%, Verizon (NYSE: VZ  ) 13%, and CenturyTel (NYSE: CTL  ) 7%. Yet fundamentally, none of those stocks has disappointed; AT&T and CenturyTel even beat their earnings estimates for the first quarter.

Moreover, if a company is unhealthy, then no dividend in the world will save it. Bear Stearns paid a steadily growing dividend right up to the very end, when it failed. Washington Mutual's dividend rose consistently for 18 years before the company made a big cut that presaged the thrift's imminent implosion. And even though Wells Fargo (NYSE: WFC  ) not only survived the financial crisis but has thrived from the competitive advantages it has gained, its 5% yield in mid-2008 didn't stop its stock from losing more than half its value. If you're not careful, high dividends can disappear like a thief in the night.

Finding safety
If you want dividend stocks that will help you protect your portfolio from a possible bear market, then you have to look for additional characteristics beyond just a good payout. In particular, here are some things to look for:

  • Good financials. If the financial crisis taught us anything, it's that relying solely on history is no guarantee of the future. General Electric and Dow Chemical had to cut dividends due to deteriorating fundamentals and cash-flow issues. When companies pay out more in dividends than they make in earnings, something eventually has to give. To make sure you don't fall prey to a dividend trap, watch the company's financial statements closely.
  • Defensive industries. Combining strong dividends with sectors known to hold up well during downturns has worked in recent bear markets. McDonald's (NYSE: MCD  ) and General Mills (NYSE: GIS  ) have both fired on all cylinders throughout 2008 and 2009, seemingly unaffected by -- or perhaps even benefited from -- the economic recession. Each pays a healthy dividend and expects to see modest but stable growth in the coming years.
  • Think preferred. Some companies, such as most financial stocks lately, pay small or no dividends on their common stock. But if they also have preferred shares, you can get dividends with less volatility from them.

It's not a foregone conclusion that all dividend stocks will perform well under all market circumstances. As with any stock, you have to be willing to endure some short-term volatility with dividend stocks in order to get a good long-term payoff. Fortunately, though, even through the worst of times, you'll at least be getting a nice check every few months to boost your confidence.

Jim Royal knows one dividend stock you ought to own. Find out what it is here.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Fool contributor Dan Caplinger thinks falling stock prices are like rain: Getting wet is no fun, but it helps make things grow in the long run. He owns shares of General Electric. FedEx is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy does one thing very, very well.


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