5 Stocks for Growth and Income

Sometimes it's easy to forget that, just like mint-chocolate ice cream, the total return from a stock is a delicious combination of two factors: an income return from dividends and capital appreciation of the stock's price.

Both are equally important, though you'll be hard-pressed to find headlines in The Wall Street Journal highlighting the fact that Reynolds American's (NYSE: RAI) income return made up 35% of the stock's incredible 814% total return over the past decade. That's right, over the past decade, the slow-and-steady dividend returns have accounted for over a third of the stock's return.

You don't hear about dividend returns very often because ... well, they're not sensational like big, daily price swings are, and thus don't make good breaking news stories on CNBC.

Good things come in small checks
Still, dividends deserve more of your attention. Not only do they provide a steady and real return of cash, but paired with a growing company, they can also be reinvested to buy more shares and augment your overall return. Consider the case of auction-house Sotheby's (NYSE: BID) stock, which was naturally hit quite hard by the financial crisis and concerns about consumer spending.

The stock fell nearly 80% from $26.60 on March 15, 2008, to about $6 in February 2009. Fortunately, Sotheby's has since recovered and trades for about $29 today. Had you bought shares for $26.60 in March 2008 and held them through today, you're back to positive territory. If you'd reinvested your dividends over this two-year period (despite Sotheby's dividend cut), you would have added shares when the stock traded in the single digits, and today your returns would be a few percentage points better.

That's the beauty of reinvesting dividends -- it forces you to invest more without having to think about it.

To find stocks that can deliver both growth and income, I used the following screen:

1. Return on equity greater than 15%: We want our companies to earn market-beating rates of return on their equity.
2. Sufficient free cash flow cover (less than 60%): It's important that our companies generate enough free cash flow (cash from operations minus capital expenditures) to cover their dividend payouts and increase them down the road.
3. Dividend yield of more than 2%: With the S&P average yield currently around 1.9%, we want to generate enough income to make it worth our while.

Here are five stocks that meet the criteria for growth and income:

Data provided by Capital IQ, as of March 16.

Put the cash to work
Whatever your risk tolerance or time horizon, don't underestimate the importance of income returns for your portfolio. Indeed, dividend stocks can end up being the most unlikely growth stocks you'll ever own because, among other things, dividend payouts force managers to allocate capital more efficiently, delivering superior and more sustainable returns for shareholders.

If you're looking for more dividend stock ideas, our Motley Fool Income Investor service can help. Advisor James Early and the Income Investor team recommend both stocks with high yields and those focused more on dividend growth. At present, their picks yield 4.1% on average and have outperformed the S&P by 7 percentage points on average since the service's inception in 2003.

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This article was originally published on Nov. 27, 2009. It has been updated.

Fool analyst Todd Wenning is looking forward to another Cincinnati Reds season. He owns shares of Procter & Gamble. Sotheby's is a Motley Fool Hidden Gems choice. Procter & Gamble and United Parcel Service Motley Fool Income Investor recommendations. The Fool owns shares of Procter & Gamble and has a disclosure policy.