5 Misunderstood Dividend Stocks and How You Can Profit

I’ve written before about the power of fat dividends to crush the market, and I’ve discussed five special dividend stocks that are poised to rapidly increase their payouts.  But it not only feels good to invest in high-yielding dividend stocks for current income -- it’s a viable long-term strategy, too. And the situation is even better if you can find stocks that are mispriced because investors do not fully understand them, so that their yields are even higher than they otherwise would be. 

Below I highlight four high-yielding but misunderstood stocks you can profit from and one you might profit from avoiding.

So why high yields?
Ask the good folks at Tweedy, Browne. They reviewed the academic and professional research and concluded that high yields lead to attractive returns over long periods. Dividend stocks also provide decreased volatility and more downside protection. Good news for those of us (like me) who invest in such stocks.

I’ve shown elsewhere that if you’re investing for yield, it makes a lot of sense go with a higher yield over faster-growing but lower-yielding dividend payers. That high yield gives you a great head start. In fact, it can take a decade or two for even the fastest-growing dividend stalwarts to catch just a reasonably growing high yielder.  

But when searching for your dividend diamonds, be careful.  Tweedy warns that investors should be wary of the very highest-yield stocks, since those high yields tend to signal a lack of investor confidence in the company’s prospects. Instead, focus on stocks in the second-highest tier, which offer better overall returns.

Let’s meet our contestants
Take a look at the following five high-dividend stocks, which are often misunderstood for a variety of reasons.

Source: Capital IQ, a division of Standard & Poor’s.

Let’s take these stocks one by one to see why they’re worthwhile investments (or in one case, not worthwhile).

In January, I was picking up shares of National Grid -- what I called “the outstanding dividend I’m buying now.”  Shares have made a nice move, up about 16% since the article was published. But for long-term holders it’s still hard to beat National Grid’s meaty yield. The U.K.-based utility operates much like a regulated toll road, getting paid when electricity or gas runs through its network.  The company’s infrastructure assets mean that its services will be in demand in any type of environment, lending stability to shares.  The same can’t be said, though, for the next stock on our list.

Great Northern Iron Ore has the gaudy yield, but the payouts of this trust rely on the volatile pricing of a commodity.  That makes the size of its payouts fluctuate, sometimes violently. And you can see that in its share price, which lost a third of its value in just a month in December.  Even worse, the trust will be dissolved in less than four years, so that high but wavering yield will almost certainly not get you back to break-even before the dissolution.

If you absolutely must play the dividend game on an iron ore stock, you might consider Mesabi Trust (NYSE: MSB), which should live longer.  But like its peer, Mesabi’s payout fluctuates dramatically, leading to a volatile stock.  With this type of volatility, these aren’t the kind of stocks I want to own for the long term.

I’ve written various articles about the special opportunity in front of Vodafone.  This U.K. telecom giant owns a 45% stake of Verizon Wireless, a joint venture with Verizon, which owns 55%. With Verizon needing cash to build out its U.S. infrastructure and the joint venture having nearly paid off its debt, many analysts have speculated that Verizon will have the joint venture pay out its profits.  That move would give a lot of juice to Vodafone, which should be able to fatten its own payout nicely.  

Annaly offers a great countercyclical buffer for your portfolio, performing better in tough times. With that double-digit yield, Annaly is a dividend investor’s dream right now, but many question its long-term staying power.  Still, look at the company’s history of growing its stock price (adjusted for dividends, of course).  The increase amounts to around 18% annually over the company’s 14 years.  While many expect the yield to come down in a more normal economy, the payout should still be sizable.

And finally we come to one of the most storied income stocks of all time, Altria -- which has more than just a few puffs left in it. The company has pricing power in its Marlboro brand, and years of soaring sin taxes seem to have failed to stub out smoking. While some analysts have predicted that smoking rates could go to zero by 2050, the U.S. rate has flatlined at 21% for the last five years.  Population growth still acts as a tailwind for Altria, and its commitment to pay out 80% of its earnings should leave income investors happy for many years yet.  

But if Altria’s regulatory and litigation risk in the U.S. is too much for you, you might also be interested in its fast-growing spinoff, Philip Morris International (NYSE: PM), which markets the Marlboro brand around the world.  The company sports 40%+ operating margins, and its dividend clocks in at a still sizable 3.7%. An added bonus is the company’s exposure to global currencies, meaning that profits go up if the dollar weakens over the next decade -- a move that superinvestor Warren Buffett thinks is bound to happen.

Foolish bottom line
These stocks look poised to deliver years of great and growing dividends to investors, and I own four of them myself.  And as research has shown, dividend stocks as a whole are a great long-term investment.

If you’re searching for more fat payouts, I invite you to take a look at 13 other dividend stocks – including one I’ve called the dividend play for a lifetime -- in a free report from The Motley Fool called "13 High-Yielding Stocks to Buy Today." Hundreds of thousands have requested access to this special free report, and now you can access it today at no cost. To get instant access to the names of these 13 high yielders, simply click here -- it's free.