This High-Yield Dividend Portfolio Will Beat the Market

There's a hot debate going on at The Motley Fool, and Fools are putting real money where their mouths are. We have been debating which is better: high-yield stocks or high dividend-growth stocks (nerds!). My colleague Jeremy Phillips has gone so far as to invest $10,000 in his Outstanding Dividend Portfolio, saying, "I believe dividend growth, much more than current yield, is critical to a successful dividend portfolio." I'm on the other side with our senior retail analyst Jim Royal and firmly believe high yield beats high growth.

I'm so convinced that I'm also going to put real money behind my conviction. On Feb. 22, I'll be investing $10,000 of my retirement portfolio into 10 high-yield stocks and promise not to sell them for a full year. Today, I'll tell you why I believe in high-yield dividends and give you my 10 stock picks.

High-yield stocks
High-yield portfolios are often dismissed as inferior to their growth counterparts for various reasons:

  • Many people fear that increasing dividend yields means lower portfolio returns.
  • Others believe that dividend payments mean management believes the business is done growing.

Evidence compiled by Tweedy Browne refutes these falsehoods. Research shows that portfolios of high-yield dividend stocks outperform lower yielding portfolios and the market in general. In fact, a study by noted finance professor Jeremy Siegel found that over 45 years, the highest yielding 20% of S&P 500 stocks outperformed the S&P 500 by three times! The highest-yielding stocks turned a $1,000 investment in 1957 into $462,750 by 2002, compared with $130,768 if the same money was invested in the index.

Staying the course
There's a second benefit to high-yield stocks. Stocks with high, sustainable yields are less volatile than lower-yielding securities, since the stock price is supported by the high yield. As long as your dividend is not cut, you can expect the stock price to not have large swings. This is important, since high volatility is one of the largest factors in investors abandoning their investment strategies. With lower volatility, you are more likely to take the necessary steps of reinvesting your dividends, instead of sitting on the sidelines. If the market is done, you can take comfort in knowing that with higher-yielding dividend portfolios it is also easier to recoup losses as your portfolio will be generating ample cash to take advantage of the low prices.

A large lead
There's something to be said for getting paid now. My colleague's outstanding dividend portfolio has a yield of 2.6%, and if it grows at its historical growth rate, those dividends will grow at 23% a year. He states, "I'll be sitting on a 7.4% annual yield on my original investment in just five short years."

My superior dividend portfolio has a yield of nearly 7% right now. If nothing changes, I'll have earned 35% of my original investment during those five years, not including reinvestment. That's also assuming these high yields won't grow at all, which history doesn't bear out since the average three-year growth rate for my portfolio is 8.8%!

And here are the 10 high yielders that will make up my superior dividend portfolio:

Company

Yield

Payout Ratio

3 Year Dividend CAGR

Purchase Price on
Feb. 22, 2011

Altria (NYSE: MO  ) 6.4% 78% 31% ?
Philip Morris (NYSE: PM  ) 4.4% 63% N/A ?
National Grid (NYSE: NGG  ) 7.0% 51% 10.2% ?
Annaly Capital Management (NYSE: NLY  ) 14.5% 125% 36.6% ?
Frontier Communications (NYSE: FTR  ) 8.0% 59%* (2.1%) ?
Southern Co. (NYSE: SO  ) 4.9% 76% 4.2% ?
France Telecom (NYSE: FTE  ) 8.4% 89% 5.3% ?
Vodafone Group 4.5% 39% 7.2% ?
Eli Lilly 5.5% 42% 4.9% ?
Bristol-Myers Squibb 5.1% 71% 3.9% ?
Portfolio Average 6.9% 69% 8.8%  

Source: Capital IQ, a division of Standard and Poor's. N/A = not applicable. *Frontier's payout ratio calculated using free cash flow since it better explains the company's financial story. Its payout on an earnings basis is more than 300%.

These companies were carefully selected because they are strong, undervalued, and have a dividend yield higher than 80 percent of all companies traded in the U.S. As a group, they are diversified across geographies and industries, so if one industry suffers, the portfolio as a whole will not be greatly affected.

The next step
I believe strongly enough that these high-yield dividend stocks will outperform the market that I'm putting $10,000 of my retirement account into them on Feb. 22. My strategy is simple. I'm buying strong companies with outsized dividends, reinvesting those dividends, and holding them for the long run. Over the coming year, I'll track my performance, update you on when I'm going to reinvest all my dividends, and keep you abreast of news affecting these companies.

If you want more dividend stocks to round out your portfolio, click here to get a five-page free report from Motley Fool's dividend analysts with "13 High-Yielding Stocks to Buy Today," including five screaming buys for your retirement account.

Dan Dzombak does not own shares of any of these stocks -- yet. He will be buying $1,000 of each at noon on Feb. 22, 2011.

Vodafone Group is a Motley Fool Inside Value pick. Philip Morris International is a Motley Fool Global Gains recommendation. France Telecom, National Grid, and Southern are Motley Fool Income Investor recommendations. The Fool owns shares of Altria Group, Annaly Capital Management, and Philip Morris International. 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 Motley Fool has a disclosure policy.


Read/Post Comments (38) | Recommend This Article (160)

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 February 11, 2011, at 4:31 PM, Purpleboarder wrote:

    I like this article, and I like NGG, but I thought the yield for NGG is around 4.6%, not 7%....How 'bout EEP (w/ a 6.5% yield) as an alternative? Or even EEQ for investing within an IRA/Roth-IRA?

  • Report this Comment On February 11, 2011, at 4:47 PM, pugwee wrote:

    I also like this article.

    I recently bought FTR. My thought was that even if they cut div's by 50% (can't see that happening anytime soon) I'll still be getting 4+%. I will be interested to see how this investment portfolio pans out.

    Please keep the updates frequent and regular. Dividend investing is boring, but on bank day it's fun.

  • Report this Comment On February 11, 2011, at 5:49 PM, energysystems wrote:

    truthisntstupid-Well, I'm hoping that starting young will eventually lead to even better returns. I'm 25, and have been investing in a myriad of dividenders, the vast majority of which I re-invest the dividends with(nothing like compounding dividends), along with the fact I won't be touching/pulling money out of those accounts for atleast a few decades.

  • Report this Comment On February 11, 2011, at 5:51 PM, bernbern0 wrote:

    truthisntstupid: Please don't give up on dividend-growth. I'm a LOT older than you are...you've got many years ahead of you. Luckily, I've blindly owned stocks that I didn't realize were "dividend-growth" stocks and have done extremely well with them. Conversely, I've sold many excellent dividend-growth stocks over the years at a profit, hoping to make much bigger profits on "stocks of the day". On hindsight, I would have been much, much better of holding onto those boring dividend growth stocks. you're young. Time is on your side!

  • Report this Comment On February 11, 2011, at 5:52 PM, killerpants wrote:

    Annaly is an REIT, so its tax consequences are different. The dividends they pay out are not "qualified," so they are taxed as ordinary income and not at the 15% capital gains rate. So to get a more accurate measure of the high-growth vs high-yield portfolios' benefits to someone investing in an account with taxable gains, maybe an after-tax yield comparison is in order? Say using a tax of 30% on the REIT dividends?

    Also, the Tweedy Browne research is probably an indication that the universe of dividend-paying stocks is a self-selecting set of higher quality companies when compared to the universe of non-dividend-paying stocks. How many dividend payers are on the verge of collapse compared to the non-payers? I'm only saying this because the article refers to portfolio yield and not the yields of its components. I could construct a portfolio that is 25% SO and 75% NFLX, and its yield would be quite low. Would its subsequent underperformance lead us to conclude that low-yield high-growth stocks will underperform high-yield stocks? Or does it have more to do with whether a stock pays a dividend at all and its consistency?

  • Report this Comment On February 11, 2011, at 6:05 PM, xetn wrote:

    According to the stats, FTR is paying out 323 % in dividends. How is this possible?

  • Report this Comment On February 11, 2011, at 6:37 PM, xetn wrote:

    Looking at the stats for FTR, shows that they are paying out 323 % in dividends. How is this possible or sustainable?

  • Report this Comment On February 11, 2011, at 6:38 PM, xetn wrote:

    Sorry, that should have read 323% pay out ratio.

  • Report this Comment On February 11, 2011, at 7:05 PM, RavenandSunny wrote:

    The only pick here that I have a problem with is FTR. They are doing well now, however, they've bought Verizon's landlines in the northwest which I assume are as inherent with problems as the Verizon landlines sold in the northeast to Fair Point Communications a few years back. Fair Point is in bankruptcy because it ran out of money trying to live up to their promises to upgrade the landlines here in the northeast by bringing fast internet service to this area. I know that their dividend looks great, but this is a company that I would not be in a hurry to invest in without finding out first what their future commitments are as to how much they will have to invest to update Verizon's leavings.

  • Report this Comment On February 11, 2011, at 7:20 PM, KLE1 wrote:

    The last four stocks are VOD, LLY, and BMY respectively. I have owned FTR for a long time, don't expect much if any capital growth..I think I'm up a grand total of 10.5%..but the dividend is 8%, reinvesting the dividends is a good idea with this one. I have owned at one point or another all of the other companies..and sold them for the gain and reinvested...probably should have kept them all...but what can I say..didn't happen. I like your article and the choices. I may do the same as you but why Feb.21 (monday) at noon...just a point in time?

  • Report this Comment On February 11, 2011, at 8:40 PM, soycapital wrote:

    I've noticed that companies like CIM and NLY pay out over 100% in dividends. How is this possible? Do you want to own a company that does so? I sold my CIM at a bit of a loss right after I got the dividend in January because I found out they were over 100%

    Good article, thank you.

  • Report this Comment On February 11, 2011, at 10:12 PM, JTKASBEN wrote:

    Two questions.. I thought a "low" PR was good... only one or two look "low" LLY & VOD

    Secondly..how do you determine how many shares of each stock.. to get to that $10,000.00. (I prefer to not invest with PM.. "anti-tobacco"...) thanks jtpot

  • Report this Comment On February 11, 2011, at 11:30 PM, predfern wrote:

    The problem with many foreign stocks is that they withhold taxes from the dividends which hurts reinvestment. Please specify which stocks withhold taxes from dividends so I can avoid them.

  • Report this Comment On February 12, 2011, at 4:42 AM, nubridge wrote:

    1. How can you place only $10000 into 10 stocks at those valuations when board lots may be 100 shares?

    2. How can you reinvest dividends when the dividend amount received isn't sufficient to but a lot?

  • Report this Comment On February 12, 2011, at 10:49 AM, EDJMCPS wrote:

    I have had FTR (Frontier) in my porfolio and in my research when they bought Verizon it had a bond offering of 3.2 Billion at interest rates 1/2 those Fairpoint had to pay. It also cut its dividend to have cash for network investment. This was also stated as a "temporary thing" . This was done to integrate & upgrade the new lines for broadband service. I bought when it was in the $7.00 range currently in the $9.00 range. As of yesterday it was paying (.76) a yield of 7.99%. My cost yield is 10.87%. I would buy FTR anytime it is below $9.00 right now. I really like FTR and the story they have to tell.

  • Report this Comment On February 12, 2011, at 4:04 PM, pryan37bb wrote:

    Regarding REIT's paying out more than 100% of earnings: they get favorable tax treatment if they pay out at least 90% of their earnings in dividends, so it's not unexpected to see such a relatively high number. Although I can't explain why it's more than 100%, possibly some accounting explanation such as depreciation expenses?

    I like this portfolio a lot, but my only beef is that it's not very diversified, with several tobaccos, several telecoms, and several utilities. In that regard, might I suggest swapping out one of the three telecoms with something like JNK? That way, not only do you have a substantial yield, you're diversifying across asset classes. Or perhaps even an emerging market bonds fund?

  • Report this Comment On February 12, 2011, at 6:28 PM, CrazyIvan101 wrote:

    The yields of National Grid and France Telecom are not correct. They both pay out semi-annually.

    Based on regular payouts last year FTE is yielding about 6.0% and NGG about the same based on current prices.

  • Report this Comment On February 12, 2011, at 9:59 PM, ikkyu2 wrote:

    NLY really doesn't belong on this list. Not only does it not pay qualified dividends - viz. killerpants' comment above - but, really, you believe it's not going to cut its dividend in the next 5 years? I don't think anyone believes that. In fact, one of the reason the yield is so high is because EVERYONE knows it's going to have to cut the dividend substantially once rates start rising. It's called a risk premium and it's not the kind of money you're earning with the other wonderful stocks on your list.

  • Report this Comment On February 13, 2011, at 3:23 AM, karlm1 wrote:

    For the time being NLY is inflating your total yield. In the high interest rate arena that will come sometime down the road probably sooner than later this stock will predictably tank in share price my estimate 25% hurting your total return. The dividend will probably drop to the 4-5% range. Thats the time to add some NLY to the portfolio. Not at these bubble prices.

  • Report this Comment On February 13, 2011, at 1:27 PM, UFOFred wrote:

    How does one get basic historical information on National Grid? I've a Better Investing member (started club in 1995) and like to run potential investments through a Stock Selection Guide.

    Where do I find at least a 5-year history of things like sales, earnings, cash flow, dividends, etc? I could not find National Grid in Valueline (either regualr or small-mid cap).

  • Report this Comment On February 13, 2011, at 11:58 PM, geecheegirl wrote:

    Yes, I find at least a couple of these yields to be incorrect, also. Happens often in these articles. Also, someone mentioned a particular stock with a high dividend....that if it got cut even in half, he'd still be satisfied with the yield. But realize, too, that when the dividend gets cut, the stock price will likely tank, also. So don't get too excited over that yield.

  • Report this Comment On February 14, 2011, at 9:15 AM, bmw201030 wrote:

    Let me start by saying I love you guys at the MF but I'm not sure holding these 10 stocks for 1 year is going to prove anything. We all know that 1 year isn't a long enough window to prove which strategy is best. I'm the betting type and I understand why you guys would "put your money where your mouth is" so to speak. Maybe a more realistic approach would be to start a Caps page for each strategy and revisit it in 5 years....but what fun is that.

  • Report this Comment On February 14, 2011, at 12:24 PM, rentie13l wrote:

    If you buy a dividend that has been constant or rising over 20 years you can feel that maybe it will continue. If you buy a dividend that is only 3-4 years old it could change or be discontinued any day. Dividends are offered by companies for many reasons and some of those reasons border fraud. Any good CPA can explain how large companies can "cook the books" to create profits or losses with the stroke of a pen. The problem with American/NYSE companies is that we have NO true government supervision. It is the 'Wild West' for investors. YOu must go into these stock investments with the understanding that some of these figures, statistics, are purposely misleading and are designed (Enron) to make you lose your money. It has happened to me. I sent detailed reports to the SEC. I never even received a printed form that they received my information!!!

  • Report this Comment On February 14, 2011, at 1:22 PM, MitchinMS wrote:

    BMW, my thoughts exactly. I'd be interested in knowing whether the ongoing plan would be to hold on to these original high-yield stocks, or review and re-allocate each year to a new batch of high-yield stocks.

  • Report this Comment On February 14, 2011, at 1:55 PM, DESERTKAT42 wrote:

    Investing in dividend stocks is a great way to go. If the price goes up beyond the quarters dividend sell it. if it doesn't keep it and collect and wait for next quarter. Some of the more steady long time companies that have consistently paid dividends I buy and keep. less work, but I still check on them at least once a quarter and have alerts posted should there be sudden changes and I read the press releases. foreign stocks sometimes come with taxes, but remember that the taxes are deductable from income tax here. Be sure to calculate that into the bottom line to get an accurate profite percentage. YLWPF is a good example. I make about 11% on my money even with the loss of the foreign tax to canada. I find no problem in paying foreign tax with that kind of profit. But once again the boys of fools are sell the expensive stocks. here's a couple cheaper ones that pay a good dividend. ATAX - ALSK - CPLP - FCAR - KCAP - GOOD. on a final note I also own FTR and plan on buying more. I try and stay away from etf's but I do have a couple. I believe in diversification and try to never hold more than 1000 shares of any one stock. minimizes the loss should one suddenly fail. Since I hold more than 70 stocks it's hard to keep track of every one all the time. Investing the market isn't about luck - it's about research and constant watchfullness.

  • Report this Comment On February 15, 2011, at 2:10 PM, mikecart1 wrote:

    One of the top 5 Motley Fool articles ever written (serious).

  • Report this Comment On February 15, 2011, at 11:07 PM, pmjzzz wrote:

    To evaluate the dividend yield of an ADR based on a foreign stock you need to eliminate the effects of historic exchange rate movements. You'd probably also like to eliminate the effects of future movements - but that's kind of hard to do!

    Re NGG - because the dividend is declared on the UK shares in £, then converted into $ at the rate on the date of payment (and factored by the ADR ratio) - you need to look at the last 12 months of dividends in £ vs the current price in £.

    Dividends in 2010 were £0.2484 in June, and £0.129 in December. That's £0.3774 on a stock price of say £5.65 (mid Feb 2011) = 6.68%. So if you buy the ADR today, at whatever the current price is in $, you'd get 6.68% if future dividends do not change and if the exchange rate stays constant for the remainder of 2011. Of course it won't - so your actual dividend in $, or as a percentage of your purchase price, will go up or down depending on exchange rate movements.

    FTE is similar - 2010 dividends were €0.80 + €0.60 = €1.40 on a current price of ~ €16.25 = 8.6%. Same risk re stability of dividend and exchange rate movements.

    No tax is withheld on UK dividends to US residents - but tax is withheld in many other EU countries - see here, subject to all kinds of treaties re tax-sheltered accounts, etc:

    http://seekingalpha.com/article/248039-withholding-tax-rates...

  • Report this Comment On February 17, 2011, at 12:27 AM, jaker30 wrote:

    I don't think $10,000 is much of a commitment. If this guy is so smart, he must have a significant retirement fund. How about $100,000?

    I have close to 40% of my portfolio in high yield and growth stocks. I own several on the list but I prefer stocks that have a min of 10 yrs of raising dividends and <50% payout ratio. The exceptions are the MLP's, which pay back capital so they can pay > 100% of earnings.

    The crash of 2009 was a good test of dividend reliability. Many solid dividend payers continued to raise dividends even in 2009. The European companies are very inconsistent.

  • Report this Comment On February 17, 2011, at 9:28 AM, TMFDanDzombak wrote:

    @jaker30 The majority of Fool.com readers are investing their income – and not lump sums. $10,000 could be a day’s pay or several months of accumulation. I’m writing for an audience that’s across the spectrum, so I wanted a number that was easily multipliable to each individual’s specific situation. Thus I picked $10,000.

  • Report this Comment On February 17, 2011, at 9:31 AM, TMFDanDzombak wrote:

    A note to all readers

    The original article said I would be buying the stocks on Feb 21, 2011. I did not realize that is Presidents' Day and the market is closed. I will now be making my purchases on Feb 22nd 2011 and the article has been updated to say as much.

  • Report this Comment On February 18, 2011, at 2:04 PM, pagopeg wrote:

    as a new reader what about SID.NYSE it pays a 6.90 % div or 1.16 the stock trades at 16.83.bought the stock at 4.74 .very well run BRAZILIAN CO.

  • Report this Comment On February 18, 2011, at 4:55 PM, billqpgmr wrote:

    This looks an awful lot like my portfolio at E-Trade, and I've been very happy with it. I've picked them up over time, starting around 2001 with a few (3-4) thousand, and got a big boost when I added some inheritance to the group to fill out more from the income investor newsletter. 25% growth in the last six months isn't bad! In addition to the above, some of my major plays are PVX, DEO, LNCE, WM and SE.

  • Report this Comment On February 18, 2011, at 6:30 PM, Billy2010 wrote:

    in dividend I do all my free money here. I do reinvest all my dividends back into the same companys only they are not over valued. Let the dividends cash grow when the time is right them buy. Try only buy on the dips. You won't hit them all, But!

  • Report this Comment On February 18, 2011, at 9:05 PM, NCRICK wrote:

    For more years than I care to admit, I left the investing to a major wire house brokerage. Too late I found myself with lots of IPOs bought @ 25 and now in the low teens or worse. Also a pile of mutual funds paying little or no dividends. The broker and the trash are both history. Now if it doesn't pay a good dividend I don't consider it. Admittedly, I've missed a few APPL @ $85, WFC@8 etc. I do have some CEFs and some a bit more risky like NLY but all are "protected" by tight stop losses updated quarterly. (Don't ask me about last May's flash crash however.)

  • Report this Comment On February 19, 2011, at 2:41 PM, irwann wrote:

    I have a question. Where can I find the dividend yield history of a company? I'd like to know the historic high yield and low yield for any company that pays a dividend. Any info greatly appreciated. Thanks.

  • Report this Comment On February 24, 2011, at 3:30 PM, TMFDanDzombak wrote:

    Note: Follow Up Article Coming Tuesday

  • Report this Comment On March 26, 2012, at 10:54 AM, ebutter wrote:

    Now that the year is up, will there be a follow-up analysis article. It would be much appreciated?

  • Report this Comment On December 17, 2012, at 10:37 AM, wonder1st wrote:

    Where is the follow up article?? I have gone threw your articles since Feb and cant seem to find it?

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