It pays to know what other investors are doing. If like many investors, you're looking for stocks that combine the potential for rising share prices with the immediate gratification of receiving dividend payments, then knowing which dividend stocks have attracted the attention of the world's best professional investors is definitely worth the effort.
Earlier this month, I was inspired by an article by Maz Jadallah, the founder of AlphaClone. Jadallah's service tracks hedge funds and other institutional investors. By poring through the holdings reports that many financial institutions are required to file with the SEC, AlphaClone gives you access to valuable knowledge -- and also lets you slice and dice it to focus in on a number of different investing themes.
The top 5 dividend stocks
Using AlphaClone, I searched through a database of nearly 300 institutions to find the stocks that appeared most often among the top holdings of each manager's portfolio. With the resulting 20 stocks, I filtered out every stock that wasn't paying at least a 3% dividend. Here are the five stocks from the final list, ranked by dividend yield:
No. of Funds Holding
Johnson & Johnson
Curiously, none of these stocks were among the eight most popularly held stocks overall. Although a couple of those top-8 stocks -- Microsoft
Ultimately, the results show that institutional investors are just as interested in dividend-paying stocks as individual investors are. That stands to reason, since all investors want the same thing: reliable returns that beat the market. That raises one important question, though: Have these stocks given investors what they're looking for?
Comparing the haves and have-nots
To satisfy my curiosity, I looked at the recent returns of these stocks and compared them with the other 15 stocks that didn't make the high-dividend cut. As it turns out, the dividend-paying stocks had an average annual return of 5.9% over the past five years. The rest of the stocks clock in with just a 3.2% average annual return since 2005.
Still, past performance by itself doesn't guarantee anything. After all, bank stocks used to have some pretty sizable dividends, but they went up in smoke when the financial crisis hit in 2008. What's to say the same thing won't happen with these five companies?
There's always a possibility that a future problem will hit these stocks as hard as financials got smacked two years ago. Pfizer, Merck, and Johnson & Johnson all face the continuing challenge of bringing new drugs to market. AT&T has its legacy landline business crimping growth, and with the likely loss of its monopoly on providing coverage for the iPhone, it may see its smartphone business suffer as well. And while Chevron has enjoyed the recent run-up in oil prices, its just-announced buyout bid for Atlas Energy fully exposes it to the ailing natural gas industry -- something that ExxonMobil has been criticized for after its arguably ill-time buyout of XTO Energy.
What these stocks have that the financials didn't however, is a solid financial backing. None of them are highly leveraged companies like those financial institutions. And with the exception of Pfizer, all of them have earnings payout ratios of 50% or less, meaning that they could see a significant drop in net income without necessarily having to slash their dividends immediately.
Take the money and run
Dividend stocks do more than just hand you cash quarter in and quarter out. They often provide better overall performance than their more tight-fisted non-dividend-paying counterparts. By watching which dividend payers the pros like right now, you can get better ideas on the income-producing stocks you should be buying.
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Fool contributor Dan Caplinger never goes without dividend income. He doesn't directly own shares of the companies mentioned in this article, although he owns dividend ETFs that do. Microsoft and Pfizer are Motley Fool Inside Value selections. Chevron and Johnson & Johnson are Motley Fool Income Investor recommendations. Motley Fool Options has recommended diagonal call positions on Johnson & Johnson and Microsoft. The Fool owns shares of ExxonMobil, Johnson & Johnson, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never leaves you wanting .