Pop quiz: Which major event helped some investors to quadruple their returns over the 25 years from 1929 to 1954? Ding ding ding! You guessed it: the Great Depression.

Wait, huh?
Data from renowned dividend scholar Jeremy Siegel shows that although it took 25 years for the S&P 500 to return to its 1929 levels, those who reinvested their dividends earned a total return of 334%. How did that happen?

As Siegel explains, dividends are "bear market protectors and return accelerators," because falling stock prices lead to higher dividend yields ... and higher dividend yields allow for reinvested dividends to accumulate tons of new shares at lower prices.

And that isn't the only time dividend stocks have boosted returns for investors during bear markets.

For instance ...
When I ran the numbers over the 2000-2002 bear market, I found that dividend-paying stocks outperformed non-dividend-paying stocks by an incredible 47 percentage points on average. Granted, that particular time frame is known for the bursting of the dot-com bubble, when many non-dividend-paying tech companies crashed and burned. But over longer periods, the thesis holds.

In fact, according to research from professors Kathleen Fuller and Michael Goldstein, from 1970 to 2000, dividend-paying stocks outperformed non-dividend payers during down markets by an average of 1.5% per month!

But simply picking the highest-yielding stocks is not a recipe for success. As I've noted previously, high yields often signal danger, and when blowups do occur, the fallout isn't pretty: Companies that cut their dividends in 2008 fell by 57% on average for the year.

So it's critical to make sure your yield is safe. In January 2009, for instance, Dow Chemical was "yielding" about 11% when I noted, for a number of reasons, that it might have to take a historic cut. That's exactly what it did two weeks later -- to the tune of 64%.

How you should play it
Around the start of the current recession, our own dividend guru, James Early, revealed his basic three-part screen for how to get started researching dividend stocks in a bear market.

I was curious to see how well James' strategy works, so I conducted a study using data from the previous recession -- which, according to the National Bureau of Economic Research, began in March 2001.

The results were impressive: Stocks with James' criteria that were bought at the beginning of the recession and held for five years -- what I deem a reasonable holding period -- would have netted investors 122% on average, versus just 12% for the S&P 500!

So what were his criteria? James insisted on stocks that had:

  • Yields greater than 3%
  • Dividends that had been increased over the previous 12 months
  • Growing revenue

Here's a sampling of some of the stocks that fit those specifications back in 2001:

Company

2001 Yield

2000 Dividend Growth

2000 Revenue Growth

Return, March 2001-March 2006

Enterprise Products Partners (NYSE: EPD)

10.6%

14%

129%

93%

R.R. Donnelly & Sons (Nasdaq: RRD)

4.5%

5%

6%

35%

Caterpillar (NYSE: CAT)

3.8%

5%

2%

299%


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

Of course, times change, and none of these stocks would pass the test today. Caterpillar managed slight revenue and dividend growth over the past year, but not enough to keep pace with its steep stock ascent; shares no longer yield 3%. R.R. Donnelly & Sons experienced a slight revenue decline over the past year, and dividends were flat. Revenue also declined slightly for Enterprise Products Partners.

Why it works
Generally speaking, companies won't cut their dividend right after they've raised it, so a dividend increase during a recession is an especially strong sign that you can trust a tasty yield.

Unfortunately, there are some less savory reasons why management would raise a dividend during difficult times, such as a myopic desire to provide stock-price support, an inability to anticipate market conditions, or general incompetence.

Growing revenue is one objective sign that your investment candidates are improving their economic performance, even in the face of a tough market -- a difficult hurdle to clear. More recently, insisting on growing revenue in addition to growing payouts would have helped investors avoid disappointments such as Huntington Bancshares (Nasdaq: HBAN), which raised its dividend in 2007 amid declining revenue -- and has since had to take massive cuts. Based on analyst earnings estimates, investors will probably have to wait until at least 2013 for payouts to return to somewhere near their prior rate.

Drumroll, please ...
So which three dividend dynamos might help you to take advantage of rising yields today? Of the companies that match James' strategy, I chose three for you.

To review, each of these stocks has:

  • A greater-than-3% yield
  • A recent dividend increase
  • Growing revenue

In addition, I wanted to make sure these stocks have less than 80% free cash flow-payout ratios. Here are the results:

Company

Yield

Dividend
Growth

Revenue
Growth

Free-Cash-Flow
Payout Ratio

Waste Management (NYSE: WM)

3.5%

8%

4%

47%

Abbott Labs (NYSE: ABT)

3.6%

10%

14%

36%

Intel (Nasdaq: INTC)

3.0%

9%

30%

34%


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

Despite the recent economic downturn, each of these companies has managed to expand its business, and each has enough confidence in its ability to pay a dividend that it was willing to raise the payout.

Waste Management and Abbott operate in fairly downturn-resistance industries: Garbage disposal and drugs are two necessities that even cost-conscious customers are unlikely to skimp on even in tough times. Semiconductors rebounded quite strongly from the 2008-2009 slowdown that Intel experienced. Assuming it can respond to the risks posed by Microsoft's move to support ARM in the next version of Windows, Intel's scale advantage over rivals remains formidable.

Even more ideas
While studies such as Siegel's and Fuller and Goldstein's, as well as my own research, prove that dividend investing is an excellent strategy in down markets, the increased possibility of dividend reductions means you need to be extra-selective in your investments.

If you're looking to incorporate more dividend stock ideas into your portfolio and find out income-boosting strategies, enter your email in the box below to get our "Options Edge" handbook and "5 PRO Strategies for 2011," two new free reports with techniques and strategic guidance for the year ahead. We'll also tell you more about Motley Fool Pro, our real-money portfolio service that seeks to generate income and absolute returns in any market. To get started, just enter your email in the box below.

This article was originally published Feb. 14, 2009. It has been updated.

Ilan Moscovitz doesn't own shares of any company mentioned. Intel and Waste Management are Motley Fool Inside Valueselections. Enterprise Products Partners LP and Waste Management are Motley Fool Income Investor selections. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended buying calls on Intel. Motley Fool Options has recommended a write covered straddle position on Waste Management. Motley Fool Alpha owns shares of Abbott Laboratories. Microsoft is a Motley Fool Inside Value pick. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Microsoft. 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 Motley Fool has a disclosure policy.