What You Don’t Know About Dividend Stocks

by Richard Young | February 24, 2011 8:28 am

The powerful tailwind of lower interest rates is history. Corporate profits as a percentage of the gross domestic product (GDP) are at historic peak levels and most likely have little headroom on the upside. All this means that you are going to find dividends even more important in upcoming years.

Corporate staff reductions have been made, and the tremendous value of low interest payments for bond-issuing corporations is over. And companies with weak pricing power are going to find sledding tough as inflation cycles up.

Pay no attention to the jive Federal Reserve Chairman Ben Bernanke has been running up the flagpole on controlling inflation. When you print, you pay. Period. And the chairman is a world-class printer of money.

Further clouding the air as I write, non-farm payrolls remain below May 2010’s peak. In other words, we have a jobless recovery despite the Fed’s massive pump priming.

The investment environment remains extremely challenging, necessitating a more defensive stance than you might normally adopt.

Many of the names on our list of blue-chip dividend stocks look ready to increase their payouts this year. When you are happy with the dividend a company pays, and enthusiastic about an increase in your dividend in the year ahead, you have done as good a job as you can do in ensuring consistently positive long-term total returns.

The value of high-yielding stocks is less sensitive to interest-rate changes than the value of non-dividend-paying stocks.

This probably sounds counterintuitive to most investors, because the financial media tells you that dividend-paying stocks and bonds should be thought of as alternative sources of income, but it’s true. The chart below compares the performance of the highest-yielding quintile of U.S.-listed stocks to the S&P 500 from January 1970 to September 1981.

Dividend Stocks vs. S&P 500

During this period, 10-year interest rates increased from 7.75% to 15.84%. High-dividend payers beat the S&P by 100 percentage points. It is true that some investors will sell high-yielding stocks when interest rates rise, and this can temporarily cause them to underperform, but stock prices eventually revert to their intrinsic value.

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