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Dividends can all look alike. That $0.75 per share one company pays you each quarter looks a lot like any similar sum. But those seemingly identical payouts can vary wildly in their growth rates and stability.
The case for dividends
In a recent Wall Street Journal article, Ben Levisohn made a strong case for dividend investing. As of this summer, dividend-focused mutual funds have taken in $12.6 billion this year, almost four times the total inflow for 2010. Stock funds in general have seen outflows of roughly $25 billion.
Indeed, dividends look particularly attractive now, with 10-year Treasuries are yielding less than 2%, and five-year U.S. bonds yielding less than 1%. With inflation historically averaging around 3% annually, both these Treasury options could actually leave you poorer in the long run. Meanwhile, exchange-traded funds such as the iShares Dow Jones Select Dividend Index ETF (DVY) and the SPDR S&P International Dividend ETF (NYSE: DWX ) were recently yielding 3.5% and 5.6%, respectively. The Dow Jones Industrial Average (INDEX: ^DJI) is yielding around 2.7%, and the S&P 500 around 2.2%, so these dividend-focused funds are clearly more generous.
A look at individual stocks makes the case for dividends even clearer. My colleague Morgan Housel has pointed out that since the late 1960s, Altria (NYSE: MO ) stock has advanced 11,000% -- and with dividends reinvested along the way, that return surges to 278,000%! Admittedly, that's something of a best-case scenario. So consider somewhat less spectacular Boeing (NYSE: BA ) . It's gained 2,000% since the late 1960s, but with dividends reinvested, its return would have more than tripled to 6,100%. Both stocks should continue paying for the foreseeable future; Altria's offsetting a shrinking population of smokers in the U.S. with price hikes, while Boeing fills contracts with the military, and outfits airlines with its new 787 Dreamliner.
Clearly, dividends can contribute powerfully to a portfolio. But if you're looking at individual dividend-paying stocks, keep your needs and goals in mind. For example, are you seeking safety or growth?
Safe-ish and growing
Many dividend payers will offer some degree of both safety and growth. No stock is ever 100% safe. But most companies are paying out dividends because they have relatively predictable cash flows and believe they won't have trouble covering their dividend obligations.
In addition, most companies are in business to grow. They have shareholders to reward, and they hope and plan to be generating considerably more cash in the years to come, and to increase their dividend payouts regularly, as so many companies do.
Safety vs. growth
Still, some companies have more predictable futures, and some are growing much faster than others. If you're an older investor or one with a more conservative temperament, and you don't need to beef up your nest egg considerably, you might favor "safer" companies. To find these, you might focus on industries that don't change too rapidly, such as consumer staples. Think energy, foods, garbage, and even insurance. Johnson & Johnson (NYSE: JNJ ) has been sporting a yield north of 3.5%, and has been hiking its yield by about 10% annually over the past five years. Electricity giant National Grid (NYSE: NGG ) sports a trailing yield of about 6% and has been upping its payout by 7% annually since 2006.
You can also look for low debt levels and low betas, since both can herald steadier companies. (Beta reflects how much more or less volatile than the overall market a stock is; a beta greater than 1.0 reflects greater volatility, and vice versa.)
If you're a younger investor, or you have a greater tolerance for risk, you'd do well to seek growth. For faster growers, look at more tech-heavy companies riding the boom in solid-state memory or cloud computing, among other waves. Patent-rich Qualcomm (Nasdaq: QCOM ) is expected to grow by about 16% annually over the next five years. Its current yield isn't as hefty as some companies, near 1.7%, but it's been rising by 15%, on average, and if that rate continues, it will deliver a much higher effective yield in coming years to those who buy today.
Lots of big foreign companies are also offering tempting yields, and are serving more rapidly growing populations. Telefonica (NYSE: TEF ) , for instance, offers telecom services in Spain, Europe, and quickly developing Latin America. Its yield was recently north of 8%, and growing at more than 20% annually over the past five years.
With fast growers, it's also good to see relatively little debt, as well as accounts receivable and inventory levels growing no faster than revenue. With all portfolio candidates, it's always best to examine as many measures as possible to get the fullest picture. Be especially diligent with high-yielding stocks, as they're sometimes in trouble.
As you seek dividends for your portfolio, make sure you're getting the kind that will best meet your needs.