5 Dividend Stocks You Shouldn't Go Without

It pays to know what other investors are doing. If like many investors, you're looking for stocks that combine the potential for rising share prices with the immediate gratification of receiving dividend payments, then knowing which dividend stocks have attracted the attention of the world's best professional investors is definitely worth the effort.

Earlier this month, I was inspired by an article by Maz Jadallah, the founder of AlphaClone. Jadallah's service tracks hedge funds and other institutional investors. By poring through the holdings reports that many financial institutions are required to file with the SEC, AlphaClone gives you access to valuable knowledge -- and also lets you slice and dice it to focus in on a number of different investing themes.

The top 5 dividend stocks
Using AlphaClone, I searched through a database of nearly 300 institutions to find the stocks that appeared most often among the top holdings of each manager's portfolio. With the resulting 20 stocks, I filtered out every stock that wasn't paying at least a 3% dividend. Here are the five stocks from the final list, ranked by dividend yield:

Stock

No. of Funds Holding

Dividend Yield

AT&T (NYSE: T  ) 29 5.9%
Merck (NYSE: MRK  ) 30 4.4%
Pfizer (NYSE: PFE  ) 47 4.3%
Johnson & Johnson (NYSE: JNJ  ) 34 3.4%
Chevron (NYSE: CVX  ) 43 3.4%

Source: AlphaClone.

Curiously, none of these stocks were among the eight most popularly held stocks overall. Although a couple of those top-8 stocks -- Microsoft (Nasdaq: MSFT  ) and ExxonMobil (NYSE: XOM  ) -- pay substantial dividends that fall short of the 3% mark, many of the others pay little or no dividend.

Ultimately, the results show that institutional investors are just as interested in dividend-paying stocks as individual investors are. That stands to reason, since all investors want the same thing: reliable returns that beat the market. That raises one important question, though: Have these stocks given investors what they're looking for?

Comparing the haves and have-nots
To satisfy my curiosity, I looked at the recent returns of these stocks and compared them with the other 15 stocks that didn't make the high-dividend cut. As it turns out, the dividend-paying stocks had an average annual return of 5.9% over the past five years. The rest of the stocks clock in with just a 3.2% average annual return since 2005.

Still, past performance by itself doesn't guarantee anything. After all, bank stocks used to have some pretty sizable dividends, but they went up in smoke when the financial crisis hit in 2008. What's to say the same thing won't happen with these five companies?

There's always a possibility that a future problem will hit these stocks as hard as financials got smacked two years ago. Pfizer, Merck, and Johnson & Johnson all face the continuing challenge of bringing new drugs to market. AT&T has its legacy landline business crimping growth, and with the likely loss of its monopoly on providing coverage for the iPhone, it may see its smartphone business suffer as well. And while Chevron has enjoyed the recent run-up in oil prices, its just-announced buyout bid for Atlas Energy fully exposes it to the ailing natural gas industry -- something that ExxonMobil has been criticized for after its arguably ill-time buyout of XTO Energy.

What these stocks have that the financials didn't however, is a solid financial backing. None of them are highly leveraged companies like those financial institutions. And with the exception of Pfizer, all of them have earnings payout ratios of 50% or less, meaning that they could see a significant drop in net income without necessarily having to slash their dividends immediately.

Take the money and run
Dividend stocks do more than just hand you cash quarter in and quarter out. They often provide better overall performance than their more tight-fisted non-dividend-paying counterparts. By watching which dividend payers the pros like right now, you can get better ideas on the income-producing stocks you should be buying.

Get some more great dividend ideas. Click here to get read the Fool's free report, 13 High-Yielding Stocks to Buy Today.

Fool contributor Dan Caplinger never goes without dividend income. He doesn't directly own shares of the companies mentioned in this article, although he owns dividend ETFs that do. Microsoft and Pfizer are Motley Fool Inside Value selections. Chevron and Johnson & Johnson are Motley Fool Income Investor recommendations. Motley Fool Options has recommended diagonal call positions on Johnson & Johnson and Microsoft. The Fool owns shares of ExxonMobil, Johnson & Johnson, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never leaves you wanting .


Read/Post Comments (10) | Recommend This Article (58)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 17, 2010, at 6:40 PM, midnightmoney wrote:

    Dan, when it comes to investing I'm green as a green-shoes wearing moss-backed sloth laying in the grass, but I gotta say your reasoning on chevron smacks of someone going through the motions here. Are you prepared to say that chevron's purchase puts them at risk, really? Would you have had them wait until nat gas was flying high again, or was it a better idea to hedge their bets by easing in while prices are low? I couldn't care less about chevron, just curious if you mean what you're saying. Or if you don't.

  • Report this Comment On November 17, 2010, at 9:06 PM, TMFGalagan wrote:

    @midnightmoney -

    I was only trying to come up with some possible nightmare scenarios for the companies involved. Remember, five years ago, few people would have dreamed that blue-chip financials would ever have to cut their dividends -- but they did. While I think the probability is a lot lower for these companies, the example just tries to show that that probability isn't zero.

    best,

    dan (TMF Galagan)

  • Report this Comment On November 18, 2010, at 12:04 AM, aleax wrote:

    @germaninvestor, your statement "Only growth makes you rich!" is a terrible mistake -- you really need to run, not walk, to buy Greenwald et al's masterpiece "Value Investing: From Graham to Buffett and Beyond". If the following comment's too long, see my post at http://mutnemom.blogspot.com/2010/11/cult-of-growth-and-why-... .

    Greenwald's book contains the best and clearest explanation I've ever seen of why a company's growth is a fishing lure to investors like you -- it can destroy stockholder equity just as easily as (and more likely than) it can build it. Briefly put (but you really need the book for all convincing details!), growth doesn't come for free, especially in the general and most frequent case of a "level playing field", where a firm holds no significant "franchise" (competitive moat somehow forcing competitors to face large barriers to entry) [and let's not even get started about the costs of attacking a _competitor_'s existing franchise...!]. Only growth *within the franchise* (and, any franchise has its limits -- thus, only SOME kind or LIMITED growth...) can "more than pay for itself", yielding more funds than it costs to finance and maintain it.

    Thinking of brands or special management competence as "franchises" is myopic for a long-term investor -- customers under economic duress always can (and sometimes do...) switch to cheaper (and identical...) "store branded" products in lieu your branded, pricier offerings; and the perfect investment advice is the maxim "buy only a business so simple that it can be run by an idiot, because eventually it will". Europe, especially its largest economy, Germany, has long ago seen significant moves to store-branded products -- will the similar shift by US consumers in this crisis prove permanent, as the one forced by the '70s crisis did in Germany...? As for management -- remember what happened to AAPL in the tragic few days, not long ago, when it transpired Steve Jobs' health was in tatters and he needed a pancreas transplant...? If Apple's "franchise" is ``just'' Jobs' genius (one hopes he's built a "deep bench" for when he goes, but, how do you KNOW beforehand...?), then it's clearly just too fickle a "moat" for a prudent, long-term investor.

    Don't overemphasize growth PER SE: buy VALUE, first and foremost, and skeptically assess growth (is it organic, or by acquisition? more important, is it within the franchise, the "moat"? how broad is the franchise, i.e., how much more growth will it allow, and at what cost of capital? is it by "diworsification"? how DURABLE is the franchise? what's the quality of the "growing" earnings -- does free cash flow strictly follow earnings, or do "earnings" mostly come from swelling accounts receivable, growing "goodwill" [HA!-)], delayed tax and other payments, ...? &c...).

    In the final analysis, GOOD growth (with high cash flow, well within a broad franchise, which high barriers of entry to competitors, at reasonably low costs in capex and alas-not-accounted-as-capex indispensable ongoing investments to maintain the franchise, such as advertising and other marketing, customer relationship maintenance, and so forth) is surely worth something -- ideally, though, only as an extra "margin of safety" to a sound investment that's already justified by value analysis alone. But that's really, really rare; MOST growth is "growth for growth's sake", costing at least as much as it yields, and often much more (especially but not exclusively through acquisitions, one of the greatest overall ways to squander corporate wealth).

    Focus on VALUE, and look at (good) growth as a nice extra if you can get it. VALUE is the thing that makes you rich. The '90s, with the crazy bubble in tech, were the ONLY decade where growth stocks (esp. large-cap growth) outperformed value stocks (large AND small-cap): in EVERY other decade, for well over a century, VALUE stocks way outperformed GROWTH stocks.

    As my already-referenced post suggests, if you need any convincing on that score, go with O'Shaughessy's excellent book "Predicting the Markets of Tomorrow : A Contrarian Investment Strategy for the Next Twenty Years" -- it's particularly "firesale cheap" right now at Amazon (I suspect that may be because a new edition may be coming, but the book's value as a history lesson won't be affected by that;-).

  • Report this Comment On November 18, 2010, at 12:20 AM, bs1934 wrote:

    Is there any reason why KMP is not a good choice. It has had solid dividends forever and the CEO only pays himself $1 a year.

  • Report this Comment On November 18, 2010, at 3:40 AM, Ntoxiphied wrote:

    I like CVX JNJ XOM PM EPD

    AT&T adds unnecessary risk unless you see something I don't. They will lose the iPhone. Not an if just a when and the landline division is killing them.

    MRK and PFE pharm's are ify because the nature of the beast but I still like them for the riskier side of a portfolio.

    CVX expansion on it's NG footprint at this price point will prove to be a very wise choice. Possible short term hurt but longterm power play. XOMs move on XTO will shake out to be a good move too even though at a much worse price point and causing a llot more hurt as NG continued to drop.

    @bs1934 Kmp & Epd both high on their 52w stretch other then that I like them both. Pipelines gives some insulation to the sad N.gas market ATM caused by continued over production & new tech. Plenty of cash to cover the divys is another plus.

  • Report this Comment On November 18, 2010, at 10:33 AM, dieselpham wrote:

    Depend on what purposes of investers, they will decide that should they hold the high-dividend pay for long-term or just focus on the price of stocks in short term.

  • Report this Comment On November 18, 2010, at 8:33 PM, 1caflash wrote:

    CVX and MRK know how to cope with Economic Downturns. I really like what most folks don't mention much: Chevron is gradually getting into Alternative Energy; Merck is expanding into Veterinary [Livestock] Medications Internationally and especially in China. Let me address Growth. "Hello, Growth!" While there was a lot of GM Focus [Get It?], i did a "Wild Thing" November 18th, 2010 and purchased 83,333 shares of STTN, Smart-Tek Solutions, Inc. I paid about $5,050 at roughly .061 cents per share. I Believe this is a Shoebox Stock. I'll put the "Warning Letter" I'll receive in the shoebox. If STTN does as well as I think, then I'll break out that letter and Frame It.

  • Report this Comment On November 19, 2010, at 5:37 AM, mustang28027 wrote:

    Interesting articles and comments. I look to find solid companies that pay a nice dividend AND have a multinational exposure. That way I get growth and an income stream. PM and BTI are two stocks I own that are performing very well. I also have Yum Brands that has a good placemant in China. If you want VALUE, look to the portfoilo of Berkshire or what Bill Gates Charity owns.

  • Report this Comment On November 19, 2010, at 1:26 PM, DavidNeubert wrote:

    While I own every stock in this list. I have to caution about ATT. They have some GM-like pension obligations.

  • Report this Comment On November 22, 2010, at 7:04 PM, Willustop wrote:

    JNJ is dead money.

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