Millions of investors rely on their portfolios to help provide them with enough income to make ends meet. Given how low interest rates on bonds and other fixed-income products have gotten lately, more investors are turning to dividend-paying stocks to make up the shortfall in their overall income.
When you're hungry for income, it's tempting to grab up the highest-yielding stocks you can find. But among U.S. companies, you can often do better by sticking with yields that are slightly lower, if you can also identify stocks that will keep delivering the dividend goods year after year after year. Later in this article, I'll share some of those stocks, but first, let's look at why you don't always do best taking the high-yield road.
Morgan Stanley recently did a survey that divided U.S. dividend-paying stocks into five equally sized groups. The stocks with the highest yields went into the first group, the next-highest-yielding stocks went into the second group, and so on down to the lowest-yielding stocks in the fifth group. The company then compared performance among the groups.
What Morgan Stanley found was that unlike in other countries, U.S. stocks that had the highest yields didn't have the best performance. Rather, it was the second highest yielding group that put in top returns.
Anecdotally, one possible explanation may be that often, high-yielding stocks are set up for a fall, typically falling sharply right before a dividend cut that brings the stock's yield back down to earth. By contrast, less aggressive payouts are more sustainable and allow the stocks that pay them to have a better chance at growth and capital appreciation as well as healthy payouts.
Five prospects for your portfolio
To come up with some good ideas for further research, I looked at dividend stocks yielding between 2% and 4% that have delivered 10% dividend growth over the past one, three, five, and 10 years.
The resulting companies were quite varied, both in past performance and in industry focus. Among the top performers over the past five years were Union Pacific (NYSE: UNP ) and McDonald's (NYSE: MCD ) , both of which have more than doubled since mid-2007. High energy costs have boosted prospects for railroad companies by making alternate transportation methods more expensive, and the long boom in the industry has allowed Union Pacific to boost its dividend twice in the past five quarters to just barely reach the 2% yield mark. Meanwhile, McDonald's has benefited from strong growth around the world as it works its way into emerging market economies and builds up its overall global presence. Even as a global slowdown threatens to take hold and has pushed McDonald's stock down, the company has also stayed innovative on the menu front to keep its competition at bay.
Yet not all dividend payers have had an easy time lately. Walgreen (NYSE: WAG ) is a Dividend Aristocrat with a long history of increasing dividends through good times and bad. Yet over the past five years, the stock has lost a quarter of its value even including dividends. More recently, the company arguably made a misstep by breaking off an agreement with pharmacy-benefits manager Express Scripts, essentially forcing would-be Walgreen shoppers to go to competitors instead.
Meanwhile, solidly in the middle of the road from a performance standpoint are Intel (Nasdaq: INTC ) and Cliffs Natural Resources (NYSE: CLF ) , up roughly 28% since mid-2007. Both companies have abundant positives and negatives sending investors in different directions. For instance, Intel still rules the PC microprocessor space, but as mobile technology has become more important and now poses a threat to the long-term viability of the PC, Intel now faces a struggle to gain prominence in the mobile space.
Similarly, Cliffs was on top of the world for a long time when its coal and iron ore resources were in demand. The coal-killing factor of low natural-gas prices and falling demand for steel production in China, however, have hit Cliffs hard, and it isn't entirely clear when prices will recover. But that didn't stop Cliffs from instituting a new dividend policy that resulted in a whopping 123% jump in its payout.
No stock is a sure thing, so if you're looking at dividend stocks as a substitute for bonds, look again. But if you're willing to take on the greater risk that stocks entail, you can get a nice kicker on your income. These stocks have stood the test of time and should continue to provide healthy payouts for the foreseeable future.
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