The Powerful Advantage of Dividends

In today’s uncertain climate, with markets careening and the trans-Atlantic powers struggling to fend off a possible double-dip recession, there’s one sensible, time-honored strategy investors can count on. Capture as much of your return as you can, as soon as you can — in the form of dividends and interest.

Investors who focus on dividends and interest have a powerful leg up on investors who overlook these factors. How so? Three ways:

#1: Income-producing investments tend to hold their value better in tough markets. Bonds, in particular, often go up in price when the stock market is falling. Dividend-rich stocks may initially drop with the market, but they generally snap back sooner — and recover further — than stocks that pay little or nothing.

#2: Over the long run, stocks that deliver generous (and increasing) dividends usually appreciate, as well. Think of our utilities, food/beverage/soap stocks and master-limited partnerships (MLPs). In a low-yield environment, income-starved investors are drawn to these stocks like bees to nectar.

#3: Dividends and interest are themselves a valuable component of total return. Maybe I’m stating the obvious, but investors often forgot this truth in recent years. In the nine decades since 1930, reinvested dividends have contributed on average 53.8% of the total return from the S&P 500 index. Share prices may fluctuate, but dividends always make you richer! Without dividends, you have to rely on the fleeting and all-too-mortal genius of a Steve Jobs (or a Ken Olsen or an An Wang, remember them?) to keep your money growing.

Next: Top 5 Dividend Investments >>

Of course, a dividend isn’t worth much if the company can’t keep paying it. At this tricky stage of the market cycle, I advise you to channel the bulk of your fresh cash into stocks with impeccable records of not only maintaining but also boosting their dividends year after year. Here are three that I’m particularly keen on at the moment. 

Dividend Booster #1 – AT&T

Ma Bell has upped her payout 27 years in a row. In late August, the Justice Department filed suit to block AT&T’s (NYSE:T) proposed acquisition of T-Mobile’s U.S. wireless properties on antitrust grounds. I think the deal will ultimately go through after the parties make some concessions to pacify the government. But even if the merger is scrapped, AT&T will continue to operate one of the globe’s most enduring — and profitable — telecom franchises.

The stock’s current yield is around 6% — almost double the longest-dated Treasury bond and triple the Vanguard 500 index fund!

What to do now: Buy T up to $29.

Dividend Booster #2 – Nestle

The world’s strongest and best-managed food processor by far, Nestle (OTC:NSRGY) has had everything going for it lately — except the runaway Swiss franc. As a Swiss company, Nestle reports its sales and profits in francs. Because most of the firm’s business is conducted outside Switzerland, however, those foreign results tend to shrink when translated into a rising franc. On Sept. 6, the Swiss central bank decided to drive down the franc and keep it at 1.2 (or more) francs to the euro. This step will immediately enhance NSRGY’s earnings for the balance of 2011 and probably into 2012 as well.

Nestle pays dividends once a year, typically in April. (The payout has been sweetened 15 years in a row). The current yield is 3.8%.

What to do now: Buy NSRGY up to $59.

Dividend Booster #3 – Pepsico

Some analysts have expressed concern of late that Pepsi’s flagship brand (the soft drink) has lost market share to archrival Coke. In response, Pepsico (NYSE:PEP) on Sept. 14 tapped Al Carey, CEO of Pepsi’s successful Frito-Lay North America unit, to head North American beverages. However, PEP is much more than just a soft drink company. Snacks, such as Doritos, Fritos and Lay’s potato chips, make up 43% of sales, and ‘good for you’ nutritional foods (Quaker Oats, Tropicana, etc.) account for another 21%. In the long run, I believe PEP’s emphasis on products other than fizzy drinks will enable the company to grow faster than Coca-Cola Company (NYSE:KO), particularly in emerging markets, where the greatest potential lies. PEP’s sales to emerging markets have soared at an astounding 24% compound annual rate over the past five years.

PEP is currently yielding 3.3%. The dividend, increased 39 consecutive years, has more than tripled in the past decade alone.

What to do now: Buy PEP up to $67.

I project a total return, in the next 12 months, of 20%-30% for all three stocks (T, NSRGY and PEP), with PEP the most likely to achieve the top end of the range.

Next: 2 Safe Income Plays for a Difficult Market >>

As we speak, it’s impossible to know whether the market will regain its April 2011 highs reasonably soon, or whether that peak will hold well into 2012 (or even longer). However, we do know that Europe’s festering sovereign debt problems present a serious obstacle to economic growth around the globe. It makes sense, in a climate like this, to dial back the risk you’re taking with your stock mutual funds and ETFs.

Here are a couple of my top picks right now.

#4 – Gabelli Equity Income

Among the no-load (no sales charge) funds I’ve recommended, Gabelli Equity Income (MUTF:GABEX) stands out for its high-return, low-risk profile. GABEX has topped both the S&P 500 and 95% of its fellow large-cap value funds over the past five years. Gabelli has a five-year standard deviation (17.6%) below both the S&P 500 and the fund’s peer group (18.7%)

Current yield: 1.8%. $1,000 minimum to invest.

What to do now: Buy GABEX anytime the S&P 500 is quotes at 1230 or less (the market’s first significant overhead resistance level, dating form late August and early September).

#5 – PowerShares S&P 500 Low-Volatility Portfolio

For investors who prefer exchange-traded funds, there’s an exciting new vehicle to bring added safety to your portfolio: PowerShares S&P 500 Low-Volatility Portfolio (NYSE:SPLV). Launched in May 2011, SPLV owns the 100 lowest-volatility stocks in the S&P 500 index.

SPLV boasts a juicy 3.3% yield, making the fund a perfect choice for retirees and other income investors. In addition, the fund’s low expense ratio — 25 cents a year per $100 invested — gives you a powerful edge over actively managed funds. Indeed, you might say SPLV is itself semi-actively managed, since the fund’s holdings are rebalanced quarterly. That way, you’ll always be in the steadiest stocks the market has to offer.