There's a hot debate going on at The Motley Fool, and Fools are putting real money where their mouths are. We have been debating which is better: high-yield stocks or high dividend-growth stocks (nerds!). My colleague Jeremy Phillips has gone so far as to invest $10,000 in his Outstanding Dividend Portfolio, saying, "I believe dividend growth, much more than current yield, is critical to a successful dividend portfolio." I'm on the other side with our senior retail analyst Jim Royal and firmly believe high yield beats high growth.
I'm so convinced that I'm also going to put real money behind my conviction. On Feb. 22, I'll be investing $10,000 of my retirement portfolio into 10 high-yield stocks and promise not to sell them for a full year. Today, I'll tell you why I believe in high-yield dividends and give you my 10 stock picks.
High-yield portfolios are often dismissed as inferior to their growth counterparts for various reasons:
- Many people fear that increasing dividend yields means lower portfolio returns.
- Others believe that dividend payments mean management believes the business is done growing.
Evidence compiled by Tweedy Browne refutes these falsehoods. Research shows that portfolios of high-yield dividend stocks outperform lower yielding portfolios and the market in general. In fact, a study by noted finance professor Jeremy Siegel found that over 45 years, the highest yielding 20% of S&P 500 stocks outperformed the S&P 500 by three times! The highest-yielding stocks turned a $1,000 investment in 1957 into $462,750 by 2002, compared with $130,768 if the same money was invested in the index.
Staying the course
There's a second benefit to high-yield stocks. Stocks with high, sustainable yields are less volatile than lower-yielding securities, since the stock price is supported by the high yield. As long as your dividend is not cut, you can expect the stock price to not have large swings. This is important, since high volatility is one of the largest factors in investors abandoning their investment strategies. With lower volatility, you are more likely to take the necessary steps of reinvesting your dividends, instead of sitting on the sidelines. If the market is done, you can take comfort in knowing that with higher-yielding dividend portfolios it is also easier to recoup losses as your portfolio will be generating ample cash to take advantage of the low prices.
A large lead
There's something to be said for getting paid now. My colleague's outstanding dividend portfolio has a yield of 2.6%, and if it grows at its historical growth rate, those dividends will grow at 23% a year. He states, "I'll be sitting on a 7.4% annual yield on my original investment in just five short years."
My superior dividend portfolio has a yield of nearly 7% right now. If nothing changes, I'll have earned 35% of my original investment during those five years, not including reinvestment. That's also assuming these high yields won't grow at all, which history doesn't bear out since the average three-year growth rate for my portfolio is 8.8%!
And here are the 10 high yielders that will make up my superior dividend portfolio:
3 Year Dividend CAGR
Purchase Price on
Annaly Capital Management
Source: Capital IQ, a division of Standard and Poor's. N/A = not applicable. *Frontier's payout ratio calculated using free cash flow since it better explains the company's financial story. Its payout on an earnings basis is more than 300%.
These companies were carefully selected because they are strong, undervalued, and have a dividend yield higher than 80 percent of all companies traded in the U.S. As a group, they are diversified across geographies and industries, so if one industry suffers, the portfolio as a whole will not be greatly affected.
The next step
I believe strongly enough that these high-yield dividend stocks will outperform the market that I'm putting $10,000 of my retirement account into them on Feb. 22. My strategy is simple. I'm buying strong companies with outsized dividends, reinvesting those dividends, and holding them for the long run. Over the coming year, I'll track my performance, update you on when I'm going to reinvest all my dividends, and keep you abreast of news affecting these companies.
If you want more dividend stocks to round out your portfolio, click here to get a five-page free report from Motley Fool's dividend analysts with "13 High-Yielding Stocks to Buy Today," including five screaming buys for your retirement account.
Dan Dzombak does not own shares of any of these stocks -- yet. He will be buying $1,000 of each at noon on Feb. 22, 2011.
Vodafone Group is a Motley Fool Inside Value pick. Philip Morris International is a Motley Fool Global Gains recommendation. France Telecom, National Grid, and Southern are Motley Fool Income Investor recommendations. The Fool owns shares of Altria Group, Annaly Capital Management, and Philip Morris International. 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 Motley Fool has a disclosure policy.