Where to Find the Best Dividend Stocks
By Dan Caplinger
September 2, 2009
Investors count on dividend-paying stocks to provide them with regular income and a smoother ride than more aggressive investments. Now that the bear market in equities has turned the logic of the dividend-stock world upside down, smart investors are looking beyond their usual hunting grounds to find the best dividend stocks.
How the rules changed
Before 2008, dividend investors found many attractive stock prospects from two industries: financial companies and utilities. With financial institutions primarily making money by borrowing money cheaply and lending it out at higher rates, investors could expect regular, predictable profits that would support increasing dividend payments as those institutions grew.
Similarly, many saw the utility industry as the haven for the most conservative investors, with utility stocks earning a reputation as "widows and orphans" investments that would provide healthy amounts of income for shareholders without much risk of loss. Regulated by government agencies, many utilities could count on modest but nearly guaranteed profit margins in exchange for providing the services their customers needed.
Yet both financials and utilities have lost their good reputations among investors. Financials saw their shares decimated in the market crisis last year, as even huge banks like Wells Fargo (NYSE: WFC) and Citigroup (NYSE: C) resorted to cutting their dividends to conserve cash. And while many utility stocks have maintained their dividends, others, including Constellation Energy and Great Plains Energy, have had to cut dividends substantially.
Where the dividends are
So what should conservative investors do to maintain the dividend income they need? One idea is to look beyond the financial and utility sectors to seek out other stocks with good current dividend yields that appear to be sustainable.
To find them, I looked at a full range of sector ETFs covering the rest of the market's industries. I compared not only their dividend yields but also their returns over the past year and during the recent rally. Here's a full list:
Source: SPDR, Yahoo! Finance.
Of course, there's some subjectivity in weighing the various factors. For instance, industrials have fairly high dividend yields, but they've already seen share prices run up substantially in the rally, and they were more prone to losses during the financial crisis.
If you're looking for reasonable yields on stocks that haven't run up too much recently, then consumer staple stocks look like the best candidates right now. Core consumer staples stocks like Procter & Gamble (NYSE: PG), Coca-Cola (NYSE: KO), and Philip Morris International (NYSE: PM) all have dividend yields greater than 3%. Moreover, based on their reasonable payout ratios, many consumer staples companies appear poised to maintain or increase their dividend payments for the foreseeable future. If you're looking for safety over the potential for explosive growth, then these defensive stocks should continue to serve you well.
The health-care industry, on the other hand, doesn't have the same obvious allure. Amid the current debate over national health-care proposals, companies like Pfizer (NYSE: PFE) and Merck (NYSE: MRK) have no assurance that their business models in the U.S. five years from now will look anything like they do now, or that they'll be able to maintain current profit levels. Yet unless a final resolution to the health-care controversy results in dramatic changes -- something that looks less and less likely, the longer it continues -- those companies will continue to play a major role in health care. Moreover, the higher yields that those big-pharma stocks pay compensate investors somewhat for their risk of future uncertainty.
Stay on the lookout
If the financial crisis taught us anything, it's that conservative investors can't simply assume that what's always been safe before will remain safe in the future. By keeping your eyes open to current trends, you can shift your portfolio to dividend stocks that will give you the best chance at getting safe, sustainable income for years to come.