By Dan Caplinger
Even with thousands of U.S. companies to choose from -- and thousands more international giants -- some of the best stocks you can buy are hiding in plain sight.
Sound crazy? It's a fact. For proof, you don't have to look any further than the 30 members of the Dow Jones Industrial Average.
You won't find any higher-profile companies in the world than the Dow 30. These elite corporations have businesses that dominate not just the U.S. economy but the world economy. They're household names for billions of consumers around the world, they have brands whose values range well into the tens of billions of dollars, and they tend to pay consistent, reliable dividends.
Today's investors require more than just market-beating performance. You also want reliable income from your investments, as well as a smooth ride even in volatile markets.
That may sound like a tall order. But the fact is that dividend-paying stocks have delivered exactly that kind of dependable performance for decades. In fact, if you look back over the past 40 years, you'll see that dividend-paying stocks crushed their counterparts that didn't pay dividends. Looking at the numbers, dividend stocks outperformed non-dividend stocks by 7 percentage points annually. Over that almost-40-year span, that meant the difference between not even doubling your money versus multiplying it by 24 times.
Why are dividend stocks so valuable? The fact that they pay out cash to shareholders quarter after quarter forces dividend-paying companies to be honest about their businesses. A company may be able to hide behind accounting gimmicks and other tricks when it comes to the numbers it reports on a balance sheet, but when a company has to cut you a check every three months, many of those tricks simply don't work. In a world where financial scandals have become all too familiar, the comfort of dividends doesn't just mean better returns - they also help you sleep at night.
As you go looking for great dividend stocks, though, there are some pitfalls to watch out for. Keep reading to discover the high-dividend companies you might want to avoid as well as the three Dow stocks we think will prosper for years to come.
As with many aspects of life, it's possible to have too much of a good thing with your investments. When it comes to dividends, for example, many investors make a big mistake by immediately gravitating to the highest-yielding stocks they can find.
One popular strategy looks specifically at the top-yielding Dow stocks. Known as the "Dogs of the Dow" method, the strategy has you buy the stocks in the Dow that have the highest yields at the beginning of the year. These stocks remain in your portfolio throughout the year, and you replace them at the end of the year with whichever stocks are then the highest yielders in the Dow.
Unfortunately, that method hasn't had the best track record. In 10 of the past 16 years, it has underperformed the Dow itself.
One reason is that the highest-yielding stocks in the Dow tend to be in the same industries year after year. For instance, AT&T and Verizon have once again been named the top two Dogs of the Dow for 2013, marking the fourth consecutive year they've led the list. Moreover, looking further back at history, telecom stocks have consistently been among the top yielders of the Dow over the years.
But both AT&T and Verizon have much different businesses than they did when they joined the Dow. The days of utility-like legacy landlines are largely over, and both companies have now become primarily mobile network giants. At the current pace of technological innovation, both AT&T and Verizon have to make huge capital outlays to support their growth. Recently, that has worked out well for the two stocks, as the revolution in mobile devices has given them pricing power almost to name their own price for data plans. Yet unlike their landline networks, which served them well for generations, mobile networks that adequately handled customer loads for a short period can become obsolete in the blink of an eye as new devices continually test their limits.
Similarly, you'll find pharmaceutical stocks Pfizer and Merck in the top five Dow Dogs for the past three years, as well as at various times in past years. Yet those current high yields reflect vast uncertainty about the future of Big Pharma. Investors foresaw years in advance that both Pfizer and Merck would have blockbuster drugs coming off patent, and share prices fell in light of that uncertainty, boosting dividend yields. Recently, these companies have seen their shares move higher as they've taken substantial steps to replace the huge revenues they've lost to generic competition. Yet if those efforts prove to be less effective than Big Pharma companies hope, then yields will eventually fall due to future dividend cuts rather than further gains in share prices.
So if the highest-yielding stocks aren't the right place to find the truly best Dow dividend stocks, where should you look? Click below to discover the names of three top Dow stocks that have truly stood the test of time.
Picking the best dividend stocks in the Dow takes more than just finding a high yield. It also takes an ongoing commitment from a company to keep its payout growing over time. If you're planning to hold onto stocks for five years or more, dividend growth is a lot more important than current yield to your eventual results.
Dow investors can have the best of both worlds: dividend growth and promising yields. All you have to do is look to an elite group of companies known as the Dividend Aristocrats.
Qualifying as a Dividend Aristocrat is tough. To make the list, a company needs to have raised its dividend payout every single year for at least a quarter-century. Throughout the entire stock market, only a few dozen companies qualify for this prestigious list.
Companies like ExxonMobil, the world's largest oil and gas company, qualify for this distinction, but even after a more than 20% dividend boost in early 2012, Exxon's dividend yield is still relatively low compared to other Dow stocks. In addition, you want to take into account the durability of a company's business model. Wal-Mart [NYSE: WMT], for example, has proven its muster in retail, but even as it has started growing again after a prolonged slump, the company will still have to wrestle with the ramifications of on-line powerhouse Amazon.com on its core big-box retail business.
Fortunately, the Dow is loaded with companies with solid dividend payouts and highly sustainable business models built for the long haul. The three stocks below all have an X factor that makes them stand out from their illustrious Dow peers. Let's take a look.
Coca-Cola is in the pedestrian-sounding business of selling beverages. But the Atlanta giant has turned its red cursive logo into the most valuable brand in the world, with Interbrand once again reaffirming Coke's global dominance in putting a price tag of nearly $78 billion on the beverage-maker's brand.
When you've got that valuable of a brand, you have to use it as much as you can. Coke operates in more than 200 countries and grew global volumes by 5% in 2011, thanks in large part to big international sales that offset slowing demand in the U.S. market. When you add in some margin-enhancing price increases, you get a nice jump in net income, which rose 19% in 2011. Despite growing concerns about the impact of soft drinks on obesity rates, Coke continued to post reasonable net income growth in 2012 as well and has taken steps to improve the nutritional value of many of its products.
Coming in between 2.5% and 3%, Coke's dividend yield isn't the highest in the Dow by a long shot. But with 50 straight years of dividend increases and the company having split its stock as well during the third quarter of 2012, Coke has been great for shareholders for a while now -- and should continue to be for the foreseeable future.
3M may be best known for its sticky yellow paper, but the company goes well beyond Post-It Notes. The company offers 50,000 different products in diverse industries from health care and computer screens to commercial safety and security items.
An industrial-focused company like 3M inevitably endures plenty of ups and downs in its business cycle. But the company has a 54-year streak of increasing its dividends year in and year out, regardless of what's happening in the overall economy.
Moreover, the company is just getting started. With innovation remaining a key component of its success, 3M is moving forward with many initiatives. For instance, at the most recent Consumer Electronics Show, 3M unveiled an 84-inch multi-touch display prototype, seeking to make large-scale display walls as commonplace as chalkboards in school classrooms 30 years ago. And with strategic moves like its recently finalized purchase of ceramics-maker Ceradyne in an $860 million deal that will let it take advantage of the broader use of ceramics across several industries, 3M is positioning itself for both growth and dependable earnings for years to come.
It's comforting to see products in your home every day that come from a company whose stock you own. With P&G, it's almost a sure thing that you'll get that psychological boost. The company has more than 4.2 billion customers in 180 countries across the globe. About two dozen of its brands rack up at least $1 billion in annual sales.
But success hasn't cooled P&G's drive to dominate the world. The company has worked hard to boost its presence in emerging markets, with plans to enter 950 new market segments across various countries, product categories, and distribution channels in the next several years.
Recently, P&G has received substantial criticism, especially from activist Bill Ackman, over its slowing growth and some miscues in pricing and product innovation. Moreover, the company has faced a tough economic environment, with high commodity costs weighing on margins and overall slowness in the global economy hurting its sales.Yet regardless of his calls to replace CEO Robert McDonald, Ackman's willingness to take P&G on as a project should demonstrate how much potential the company has for the future. The outcome will likely be favorable for long-term investors in the stock no matter what shape it takes.
With an attractive dividend in the 3% to 3.5% range, P&G investors don't suffer from a lack of rewards. Moreover, the company has raised that payout for 56 consecutive years -- and with so many growth drivers, those increases should continue well into the future.
These three Dow stocks have just about everything you want to see from a high-quality dividend stock. But as illustrious as the Dow is, it's a mistake to focus solely on Dow stocks as good candidates for your portfolio. By expanding your horizons, you can find dividend stocks that could be even better than these blue-chip standouts.
Click below to learn more about even more great companies that would make smart investments today.
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