Are These Dividend Stocks Just Right for Investors?

Over the miserable past decade for stocks, there was a corner of the market where investors stood a better chance of finding winners. What corner was that?

Given the title of this article, you can probably guess that the correct answer is "dividend stocks."

With that in mind, I've been exploring the world of dividend stocks a bit more closely, first by breaking up the S&P 500 to figure out where dividend stocks hide out in the various S&P industries. I then homed in on the historical performance of high-yield stocks and companies that had super-fast dividend growth.

So now that we've looked at the highest yields and the highest dividend growth, where does that leave us? Well, right in the middle -- that is, stocks that sport moderate yields and have moderate dividend growth.

The Goldilocks stocks
So what exactly are yields and growth rates that are not too high, not too low, but just right? That's certainly subject to debate, but for my purposes I grabbed all the stocks that had yields from 2.5% to 6% and three-year annualized dividend growth rates of 5% to 20%.

Back in January 2000, there were 111 such stocks and here's how their performance broke down:

 

Dividend Yield, January 2000

Annualized Dividend Growth, Previous 3 Years

1-Year Dividend Growth

Dividend Growth From 1999 to Last 12 Months

Dividend-Adjusted Stock Returns

Group Average

3.4%

10.3%

4.3%

19.0%

96.0%

Source: Capital IQ (a Standard & Poor's company), Yahoo! Finance, and author's calculations.

The highlight here is that the group as a whole returned a dividend-adjusted 96% over the time period. Considering that the S&P lost 23%, that's nothing to sneeze at. Of course, when I stack those returns against the other dividend groups I've looked at, they're slightly less impressive -- the high yielders returned 212% over the same period and high growers delivered 109%.

What I should note here, though, is that my criteria for the Goldilocks dividends were also the sweet spot for banks a decade ago. At that point banks were seen by many as some of the best dividend stocks out there. They had moderate-to-attractive yields and consistently grew payouts.

But, as we all know, the past decade hasn't been kind to the banking industry (or perhaps we can say that the banking industry wasn't kind to the past decade). Ten years ago, Bank of America (NYSE: BAC  ) , Regions Financial (NYSE: RF  ) , and a gaggle of other banks made the list. Since then, Bank of America cut its payout by 96%, while Regions slashed by 95%. And if my fellow Fool Alex Dumortier is correct, it might be a while before B of A, Regions, and their ilk start bumping up those payouts again.

The point here is twofold. First, the Goldilocks dividend payers may have another core group that implodes during the coming decade and drags down returns. Second, since there's no guarantee that that won't happen, it's generally a good idea to keep some diversity in your portfolio.

As with my previous two articles, I also dug up data from a second time period, this time from 2005.

 

Dividend Yield, January 2005

Annualized Dividend Growth, Previous 3 Years

1-Year Dividend Growth

Dividend Growth From 2004 to Last 12 Months

Dividend-Adjusted Stock Returns

Group Average

3.3%

10.2%

5.8%

0.6%

18.0%

Source: Capital IQ (a Standard & Poor's company), Yahoo! Finance, and author's calculations.

The bright spot was that the group once again beat the broad market -- an average 18% return for this group against a 7% loss for the S&P. But the comparison to our other two dividend groups gets even worse here. Both the high yielders and high growers posted dividend-adjusted gains of more than 75% over this stretch.

And while the dividends of the group were larger over the past year on average than they were in 2004, the 0.6% growth is hardly something to crow about.

Dividends are the bottom line
It would seem that the Goldilocks dividend stocks are the least attractive of the three dividend groups I've looked at recently. The Goldilocks group was much larger than the other two groups, though, so there's also a heck of a lot of diversity in the returns. While banks like Regions Financial badly lagged the market's return, insurer W.R. Berkley and construction equipment giant Caterpillar left the rest of the market in the dust.

So while there may be better opportunities available among stocks with the highest yields and fastest dividend growth rates, I still think the Goldilocks group could prove a fertile hunting ground. After all, I started the article by noting that dividend stocks as a group outperformed the rest of the market over the past decade.

With that in mind, here are stocks that currently fit into the Goldilocks group and that I believe will be just right for investors.

Company

Dividend Yield

Previous 3-Year Dividend Growth

The Travelers Companies (NYSE: TRV  )

2.7%

7.3%

Chevron (NYSE: CVX  )

3.6%

8.9%

General Dynamics (NYSE: GD  )

2.6%

15.4%

Public Service Enterprise Group (NYSE: PEG  )

4.2%

5.3%

sanofi-aventis (NYSE: SNY  )

4.7%

11.1%

Source: Capital IQ, a Standard & Poor's company.

Rather than being a random selection from among the current list of Goldilocks dividend payers, I believe the underlying business strength and current valuations of the stocks above make them some of the best picks from the group right now. In addition, I chose from among a handful of industries. While there may be more than a few companies in the oil and gas sector right now that I think are good buys, I don't think it serves most investors well to overload their portfolio with picks from any one sector.

But these are far from the only Goldilocks dividend payers that are worth your investment dollars. Have a favorite of your own? Head down to the comments section and let me know why your pick is a must-have.

Is it all clear for investors now that the recession is officially over?

General Dynamics is a Motley Fool Inside Value selection. Chevron is a Motley Fool Income Investor recommendation. The Fool has established a bear put spread position on Caterpillar. Try any of our Foolish newsletter services free for 30 days

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. 

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


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