7 Stocks to Build Wealth in a Dead Market

Recently, I wrote a piece suggesting that dividend stocks are a "must-own" now, based on three arguments, one of which was that were are presently in a "range-bound" market, in which stock prices tread water over a long period without displaying a long-term trend. It's worthwhile to explain this argument at greater length, because I think its significance is misunderstood. Unless investors harness the power of dividends, they're likely to earn very poor returns from their U.S. stock portfolio over the next few years. Here's why.

Are we in a range-bound market?
This is difficult to say with absolute certainty, but there are good reasons to think we are. For one, range-bound markets aren't uncommon: By some measures, they cover over two-thirds of the last 140 years of market history! This is probably difficult for the current generation of U.S. investors to grasp because most of their investing experience is coincident with the massive bull market that began in 1982.

The long wait
After bubbles collapse -- the situation we're in now -- markets can take a very, very long time to recover their previous highs. These periods allow stocks to "grow into" the valuations they had previously achieved purely as a result of speculative excess. Using closing prices for the Dow Jones Industrial Average, the following table illustrates just how long these periods can be:

Source: Dow Jones Indexes.

Dividends: From substitute to star player
In such range-bound markets, dividends play an absolutely vital role:

Source: Active Value Investing: Making Money in Range Bound Markets, Katsenelson (2007).
*Note that the price return and dividend does not sum to the total return because of the geometric interaction between the components.

Dividends contributed 90% of stocks' total return!
The data is clear: In a bull market, price gains dwarf dividends, with the latter only contributing about one-fifth of stocks' total return. However, in range-bound markets, which are characterized by weak price returns, that contribution expands dramatically, to approximately 90% of stocks' total return.

Thus, ignoring the impact of dividends in a sideways market vastly understates investor returns. For example, while it took the Dow over 25 years to recover its 1929 high, data from Ibbotson Associates (a division of Morningstar) shows that investors who placed a lump sum in the broad market at its 1929 peak would have broken even on an inflation-adjusted basis in late 1936.

(This is not all due to the dividend return, as deflation also played a role, but there is no question that dividends had a significant impact on shortening the "total return" breakeven period: According to data compiled by Robert Shiller, in June 1932, the dividend yield on the broad market was nearly 14%!)

The bottom line
Let me summarize the argument here: We are now in a range-bound market. Therefore, investors should expect weak stock price gains, while dividends contribute the lion's share of total returns. In that context, investors should tilt their stock portfolios toward high-dividend stocks that pay a sustainable dividend. Here is a shortlist of seven stocks that I think fit into that category:

Source: Capital IQ, a division of Standard & Poor's.

For more dividend stock ideas
Let me emphasize that these are merely suggestions and you should certainly do your own due diligence before considering purchasing any of these shares. Alternatively, if you'd like more ideas -- ideas that have been fully researched and vetted -- you can see Motley Fool Income Investor's 5 Buy Now stocks by taking a 30-day free trial to the service. If you want to do more than just tread water in this market, they're the kind of stocks that should be the linchpin of your strategy.

Fool contributor Alex Dumortier, CFA, has no beneficial interest in any of the stocks mentioned in this article. Paychex is both a Motley Fool Inside Value and a Motley Fool Income Investor choice. Motley Fool has a disclosure policy.