Money Morning Article of the Week
by Ben Gersten, Associate Editor, Money Morning
Some investors fail to realize that successful investing is a matter of continuous performance, not instantaneous performance. That's why we like dividend-paying stocks.
Over time, dividends and reinvestment can account for 85%-90% of total stock market returns. In some cases, the dividends are so steady and increase so much that you actually make more in dividends than you paid to buy the stocks that produce them. (Click on picture for larger image.)
And as inflation concerns grow following QE3, investors need to make sure they are protected. Money Morning's Global Investing Strategist Martin Hutchinson says dividend-paying stocks offer that protection:
"Do you know what the ultimate investment protection is? It's not gold, and it's certainly not Treasuries. It's dividend stocks."
But before you go hunting for the best dividend-paying stocks, let's set some ground rules for evaluating which ones are most valuable.
- First, a good cutoff is a stock with a yield close to 3%, preferably higher, and a payout ratio less than 60%. Any higher payout ratio would indicate that the company cannot sustain the dividends, manage debt and grow at the same time.
- Second, look for companies that have price/earnings ratios less than 25 and a solid history of paying and increasing dividends.
This establishes a solid benchmark for dividend stocks and their fundamentals. Sometimes a dividend stock can look great because it has a 10% yield, but you have to look at the other numbers to decide if it's a worthy investment. To avoid those high-yield traps, check out this list of some of the best dividend-paying stocks to buy right now.
The Best Dividend-Paying Stocks
Best of the Dow- Chevron Corp. (NYSE: CVX): While AT&T Inc. (NYSE: T) has the highest yield in the Dow, its payout ratio is over 200%, immediately dropping it from our list. Since we last analyzed Chevron as a dividend stock it has gained 18% and should continue this upward trend. Chevron sports a dividend yield of 3.1% with a very nice 26% payout ratio. Chevron has increased its dividend for 24 consecutive years. If it keeps that streak up next year it will join the elite Standard & Poor's "Dividend Aristocrat" list of companies that have raised dividends for 25 straight years.
Best Diversified - Emerson Electric (NYSE: EMR): Emerson Electric has increased its dividend every year since 1957 and over the past 20 years increased dividends at an annual 8% compounded growth rate. It has a payout ratio below 50% and there should be no reason why it won't continue raising its dividend. Currently the company boasts a 3.2% yield and investors should expect that to rise along with its stock price. Emerson Electric has an average price target of $55.60 which is more than a 10% premium from its current price.
Best Tech - Cisco Systems Inc. (Nasdaq: CSCO): In an industry where solid dividend-paying companies are hard to come by, Cisco is starting to stand out. Not long ago Cisco was considered a dot-com stock that fell when the bubble burst, as well as one that had generated little return for over a decade. But over the past year it has transitioned itself into a dividend-paying stock and recently increased its dividend by 75%. Cisco currently pays out a 2.93% dividend and has made it clear that it intends to raise dividends again in the near future. Its low payout ratio of 37% gives it plenty of room to do that. Even better, the average target price for Cisco is almost 15% above its current value.
Best Recession Proof - Procter & Gamble Co. (NYSE: PG): The consumer goods conglomerate whose brands include Crest, Duracell, Gillette, Old Spice and Head & Shoulders should do fine when the next recession comes. PG has increased dividends every year since 1954 and currently has a dividend yield of 3.2%. Its payout ratio is a bit high, right near 60%, but if you're looking for a dividend-paying stock that will handle the next recession this is a great place to start.
Best Global - ABB Ltd (NYSE ADR: ABB): ABB, an innovating company based in Switzerland, is a global leader in power and automation technologies that narrowly beat out Siemens AG (NYSE: ADR: SI) for the best global dividend-paying stock. ABB sports a healthy 3.5% yield with a manageable payout ratio of 50%. Its stock has turned around over the past few months even as the European debt crisis has continued. ABB is up over 24% in the last three months and has plenty of upside potential left.
Best ETF- SPDR S&P Dividend ETF (NYSEARCA: SDY): This fund tracks the S&P High-Yield Dividend Aristocrats Index. It holds 60 companies from the S&P 1500 Index that have lifted their dividends at least 25 straight years. Most are high quality large-cap stocks that trade at reasonable prices. The fund offers a 3.15% yield. There are many exchange-traded dividend funds as well as mutual funds that offer a similar investment. If you are interested in these just make sure to check their major holdings, risk, expense ratios, yields and returns to make an educated judgment. One final thought: The opportunity in these investments is perfect for this market environment. With such uncertainty looming over the economy, these dividend-paying stocks offer protection as well as strong returns.
Editor's Note: How to spot hot dividend stocks and avoid high-yield traps is the kind of investor education we offer you in our Private Briefing newsletter. Just click here for information on how you can learn to spot winning trends and investments, side-step the losers, and profit as you go.
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