Investors have never been hungrier to pick up stocks with big dividend yields. But if you want to get the safety that a diversified portfolio brings, you can't afford to have all your money in the same well-known blue chip dividend stocks. To make sure you truly have the best stocks you can find, you have to go off the beaten path to find dividend-paying companies that few people pay much attention to.
Later in this article, I'll give you some ideas of dividend stocks that deserve a second look. But first, let me get you started looking in the right general direction.
Dividend stocks 2.0
Last week, I took a look at several stocks I believed could be tomorrow's dividend kings. They were all big-name bank stocks, and whether you love them or hate them, nearly everyone knows a lot about these companies -- all too well in most cases, because of their role in the financial crisis and the accompanying stock market meltdown two years ago. Their potential comes mostly from the prospect of their raising their dividend levels back to where they were before the crisis, at which point many of them were dividend-paying stalwarts that income investors counted on for their dependable payouts. After cutting dividends during the crisis, several of these stocks are now finally able to restore their payouts at least partially.
But as well-established large-cap companies, big banks aren't going to give you much growth potential. With the specter of regulation looming over them, banks might make their shareholders happy with the dividends they pay, but capital gains may be a long time coming.
So instead, I wanted to find what I call dividend princes -- smaller companies that already pack a big wallop with their payouts. Finding them can be tough, though, because tiny companies that are still in their growth phase often don't pay dividends; they're too busy plowing any excess cash back into growing their business further. Between small-cap and large-cap stocks, though, you'll find an in-between area that many investors ignore -- yet which holds huge opportunities for those who venture there.
Mining the mid-caps
Mid-cap stocks don't get a lot of attention, but they combine some of the most attractive elements of both their smaller and their larger counterparts. Mid-caps often have long track records behind them and have established themselves as true players in their industries, with legitimate business concepts and proven success. Some mid-caps are well-enough established that they even have excess cash to distribute as dividends. Yet they're still small enough to give investors the prospect of substantial capital appreciation.
To try to find the best mid-cap dividend stocks, I looked for stocks with reasonable earnings multiples of 20 or below that paid at least a 3% dividend yield. Among the stocks that came up were the following:
5-Year Average Annual Return
Arthur J. Gallagher & Co.
Source: Capital IQ, a division of Standard & Poor's.
These stocks definitely aren't household names -- the one you're probably most familiar with is Deluxe, the high-margin company that makes many of the checks you get when you open a bank account. But together, they represent a pretty diversified set of companies, ranging from OGE and Cleco in the utility sector to Universal's tobacco production, Questar's oil and gas exploration, and insurance broker Gallagher.
But despite their small size, they've had pretty good runs in their stocks over the past five years, especially when you consider just how pitifully small the overall market's returns have been during that time. And with earnings multiples that aren't too big, those shares could keep rising without becoming overvalued.
Take a closer look
The danger of mid-cap stocks is that as a group, they've already posted some impressive gains. In fact, they've outpaced the S&P 500 by a wide margin over the past two years, prompting some to believe that they may be overdue for a correction.
But even if a pullback comes, healthy dividend payers could give you a cushion that more growth-focused companies don't. And if the recovery continues, then mid-sized companies will have the advantage of being more flexible to adapt to new opportunities.
If you've focused mostly on blue chips with your investments, step outside your comfort zone and do some research on these and other mid-cap stocks. The dividend princes you find may well become the kings of your portfolio for years to come.
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