What the Best Dividend Stocks of 2014 Tell Us About Their Industry

Source: Flickr user Chas Redmond.

Dividend stocks remain more popular than ever, and given the edge that these high-income investments provide shareholders with both regular payouts and share-price appreciation, the popularity of dividend stocks isn't the least bit surprising. What is surprising, though, is that the best dividend stocks of 2014 so far have all come from the same industry. And what's happening in that industry sheds some light not only on those stocks, but on dividend investing more broadly.

So far in 2014, the S&P 500 hasn't come close to matching its 30%-plus performance of last year, having gained a modest 8% year to date. But when you look at the stocks within the S&P 500 that have at least a 3% dividend yield -- a group that includes nearly half of the 500 stocks in the index -- you'll notice something interesting: Out of the top five performers so far in 2014, three come from the same industry subgroup.

The rural telecommunications industry has long been famous for giving investors high yields, but the share-price gains reflect not only demand from dividend investors but also changing prospects for the industry as a whole.

How rural telecoms have smoked the market this year

Rural telecoms have combined lucrative dividends with impressive returns in 2014. Windstream (WINMQ) has led the way with a nearly 50% gain since the beginning of the year, and its almost 9% dividend yield leads its peers. Frontier Communications (FTR) has done almost as well, with a 49% gain to go along with its 6% dividend yield. CenturyLink (LUMN -5.15%) brings up the rear but still weighs in with a strong 36% jump to supplement its 5.2% yield.

Interestingly, Windstream has taken criticism for a long time, with many believing that the company's dividend strategy is flawed. Although Windstream has avoided making the dividend cuts that Frontier and CenturyLink have made, skeptics point to troublesome trends not only in its legacy landline segment but also in its commercial segment and its residential video and broadband business. Moreover, with billions of dollars in debt, Windstream has prioritized dividend payouts over debt management, which some fear could have bad consequences in the long run.

Source: National Archives and Records Administration via Wikimedia Commons.

Yet Windstream has still managed to make strides toward a more sustainable business model. A huge part of Windstream's gains came after the company said it will spin off some of its assets into a real-estate investment trust. Investors applauded the move in part because it will give the REIT and its shareholders some minor tax advantages that otherwise wouldn't be available to the telecom, and the reduction in debt for the operating company will also help it expand its offerings to customers more quickly. Proponents of the Windstream move hope that it will bolster growth initiatives as the company tries to keep diversifying beyond its decaying landline business.

Counting on dividend success
Elsewhere in the rural telecom space, Frontier and CenturyLink have also come along for Windstream's ride. Frontier has the opportunity to use a similar REIT-spinoff strategy with some of its telecom assets, and some analysts believe it could see benefits that closely resemble what Windstream anticipates in terms of freeing up capital for better use while also allowing a reallocation of its debt load. For CenturyLink, there are encouraging signs that the company's decision to reduce its dividend and put that capital toward share buybacks has started to pay off. CenturyLink has also seen strength in both its consumer and business segments.

The key for these dividend giants, though, is that most of the industry's recent strategic moves haven't been directly tied to their payouts. Sometimes, reducing a dividend can actually be the best path to long-term success, even if dividend investors initially react badly to the news. While these companies all recognize the value their shareholders put on dependable income, they also know that investors want to maximize total returns, and doing so depends on finding ways to grow rather than simply squeezing the last bit of cash flow from a dying line of business.

In the past, dividend investors have often gotten burned by chasing the highest-yielding stocks available. For CenturyLink, Frontier, and Windstream, though, shareholders just might end up having their cake and eating it, too. That's an opportunity that dividend investors should always be on the lookout for.