This Is the Best Dividend Play in the Market

If you're a dividend investor like me, your ideal dividend stock would have these four traits:

1. Stability
2. Growth opportunity
3. A big yield
4. The ability to thrive in various market conditions

That's an ideal, of course. Good luck finding all of that in one stock. But if you'll allow me to cheat a little, I will tell you about a group of six stocks that, when bought together, may be able to achieve this ideal.

The play
The six stocks I'm talking about are really three pairs of related companies.

Let's break this down by the four traits I mentioned earlier:

Stability
ADP and Paychex provide a good deal of stability to a portfolio. Since they process payrolls, they're hurt by high unemployment rates. However, they are able to weather the ups and downs of the economy with their rock-solid balance sheets. (Did I mention ADP is one of only four non-financial companies with AAA-rated debt?)

Altria and Philip Morris International provide stability with their brand power and free cash flows, but their balance sheets are more leveraged, and they face a number of threats through litigation and taxation. Yet, as one company or separate companies, they've racked up an amazing history of disproving the naysayers.

Annaly and Chimera are operating in an ideal environment right now. With the Fed keeping interest rates artificially low, the spread between what Annaly and Chimera can borrow at and what they can invest in is high. While these companies are smart enough to lock in a significant portion of these spreads through interest-rate swaps, it's probably overly optimistic to believe that these dividend yields will stay above 15%. Remember that as REITs, these two must pay out 90% of their taxable income in dividends. Hence by definition, their dividend payouts will be more volatile than the other four companies. As an additional consideration, much like with Wall Street firms, it is very difficult for an individual investor to properly assess the trading operations of these two.

Growth opportunity
As the big dogs of the payroll-processing industry, ADP and Paychex have some pricing power and some room to expand their businesses. Analysts expect five-year growth rates greater than 10% for each.

With just 16% market share, Philip Morris International has a huge opportunity to grab a bigger piece of the international market pie. Altria's domestic cigarette market share is already around 50%, and cigarette volumes in the U.S. are on the steady decline. Altria's growth strategy is purely pricing power. With its brand and the inelastic demand for tobacco, it can certainly achieve that goal, but it'll have to settle for constrained growth.

As I explained earlier, Annaly and Chimera are in an ideal situation right now. To expect growth on top of that is pushing it. For what it's worth, analysts expect 1.6% growth for Annaly and 8% growth for Chimera over the next 5 years.

A big yield
Here's where Annaly and Chimera shine. The dividend yields of ADP and Paychex are almost puny in comparison, but those yields come with stability.

The ability to thrive in various market conditions
Of course, with these six, we get the diversity of three different industries: -- payroll processing, tobacco, and the mortgage industry. ADP and Paychex sell their services to businesses, Altria and Philip Morris International sell their products directly to consumers, and Annaly and Chimera compete in the capital markets.

In addition, consider this situation. If the Fed raises interest rates, Annaly and Chimera would likely lose their ability to generate huge interest spreads. ADP and Paychex would also be affected negatively by possible near-term economic sluggishness. However, they both earn interest on their float -- the payroll money they keep before they cut checks for their clients. Higher interest rates mean higher rates of return.

Putting it all together
We could dicker about the exact composition of this mini-portfolio.

Perhaps for stability, you prefer McDonald's and Wal-Mart to ADP and Paychex. You may see upside in the 4% dividend yield of commercial REIT Crexus, another company managed by Annaly Capital. Or, for a bigger yield, you may like rural telecom Windstream (Nasdaq: WIN) and its 8.8% dividend.

However, the general principle stands: Diversification in your dividend portfolio can shore up weaknesses in the individual stocks.

To use my example, folks who value stability over eye-popping dividend yields will want to weight the dividend portion of their portfolio toward stocks like ADP and Paychex. Those who can take a bit of risk with their high yields can look to companies such as Altria and Philip Morris. And for those who can properly evaluate the business models of companies like Annaly Capital (and I can't overstress what a big "if" this is) and sift out the legitimate big dividends from the dividends bound for big cuts, there is opportunity in the big yields.

Remember three things as you build out the dividend portion of your portfolio:

1. Not all dividend stocks are the same. They run the gamut from "safe and boring" to "risky and complicated."
2. A diversified dividend portfolio across this spectrum helps smooth out company-specific risk
3. Weight your dividend portfolio based on your own risk tolerance and circle and competence.

As Treasuries and savings accounts offer miserly yields these days, dividend stocks become that much more attractive. But as always, do your homework, allocate your assets properly, and wait for the right prices. Good luck out there!

For more dividend stock ideas, check out seven from my colleague Matt Koppenheffer.