These Are Perfect Dividends

If you're a savvy investor, you know that rapidly growing stocks can turbocharge a portfolio. Cisco Systems (NASDAQ:CSCO) has gained an average of more than 30% per year over the past 20 years, while Research In Motion (NASDAQ:RIMM) has averaged more than 20% over the past tough decade. But you also know that for every Cisco, there's an Ericsson -- a company that doesn't quite deliver on its promise.

That uncertainty sends many savvy investors toward the apparent safety of dividend stocks. But not all dividend payers are alike -- and some are more promising than others.

Making a case
First, let's make sure we're on the same page about the utter desirability of dividend payers. Jeremy Siegel of Wharton Business School found that between 1957 and 2001, investors focusing on solid dividend payers earned between 2.5 and 4.5 percentage points more than other investors in annualized returns. And between 1871 and 2003 (Siegel's famous for examining long periods), a full 97% of the market's overall return came from reinvesting dividends.

My colleague Adam Wiederman has noted that according to Bloomberg data, "... even though the 10-year trailing return of the Dow Jones Industrial Average was negative through Sept. 30, when you factored in dividends, the return was actually a positive 18%." Not too shabby.

The evidence doesn't end there. Between January 1926 and December 2006, 41% of the S&P 500's total return came from dividends. If you invested $10,000 in the S&P 500 in 1926, it would have grown to $1 million by 2006 without dividends. But with dividends, it would have become $24 million!

This porridge is just right
Now that we've established dividend stocks' superiority, one question remains: Which dividend payers are best? For the answer, let's turn to Goldilocks, who passed on porridge that was too hot and too cold, and beds that were too hard and too soft, before settling on options that were just right.

Similarly, you don't want dividend yields or growth rates to be too low or too high:

• If yields are too low, you won't accumulate much in payouts. Why settle for 0.90% in yield, when you could get 3.5%?
• If yields are too high, they're probably not sustainable. A yield of 12% is fetching, sure, but it's in much greater danger of being reduced or eliminated than a 3% yield. (Payout ratios are also worth watching. A company that pays out 85% or 110% of its earnings in dividends is taking a far greater risk than one paying 50% or less.)
• If the dividend grows too slowly, it will take forever to deliver powerful income to you. A 4% yield might be tempting today, but with slow growth, it might only be an effective 5% yield in 10 years, whereas a faster-growing 2.8% yield might become a 7% or 10% effective yield in 10 years.
• If the dividend grows too quickly, again, it likely won't be sustainable. That said, at least you can enjoy the rapid growth while it lasts.

Contenders to consider
With those potential hazards in mind, Fools should focus on dividend payers that are just right -- offering respectable, but not reckless, generosity. Yields of 2.5% to 8%, and growth rates of 5% to 20%, could be a good place to start looking. Don't stop your search there, however; you should also examine competitive advantages, management quality, financial health, earnings and revenue growth, and all the other criteria you'd look for in non-dividend payers, too.

We've rounded up a few intriguing candidates to kick off your research:

Data: Motley Fool CAPS.

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