Today I'm relaunching my portfolio of Dividend Stocks for Income Investors.
By the end of this column, you'll know:
- Why I think all income investors need to consider a dividend stock portfolio as part of their total income portfolios.
- How the portfolio I launched in December 2005 has performed.
- The 10 dividend stocks I'm recommending now.
Interest rates, in general, are lower. The three-month Treasury bill yields just 0.09%. The yield on a two-year Treasury note is 0.87%. And if you're willing to lock up your money in a 10-year Treasury, you get paid just 3.21%.
Risk is higher. Because of the big rally in junk and other distressed bonds, corporate issues are trading at higher prices, which means you get less yield and more risk. For example, when I bought senior notes of homebuilder D.R. Horton (DHI, news, msgs) in late 2008, I paid $9,035 for a bond with a $10,000 par value and got, instead of the 7.875% coupon interest rate, a yield of 8.69%. As of Oct. 6, that bond has rallied, and it now would cost me $10,425 to buy that $10,000 par value note, and, because of the rally, I'd collect a yield of just 7.68%. And if I bought today and held to maturity in 2011, I'd get back $425 less than I invested.
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And we're a lot closer to the turn in the interest cycle. I don't expect the Federal Reserve to start raising rates in 2009, and 2010 is an outside chance. But 2011? For sure, unless the economy slips into a double-dip recession. Remember that rising interest rates drive down the prices of existing fixed-income vehicles, such as bonds.
Investing in dividend-paying stocks is one way to either get around or minimize these problems, for three reasons:
- Though stocks have rallied 60% or so from the bottom March 9, many are still trading substantially below their 2007 highs. That's not surprising, because even after this huge rally, as of Oct. 6, the Standard & Poor's 500 Index ($INX) was still 33% below its high of 1,565, reached two years ago. That means a stock such as Chevron (CVX, news, msgs), which on Thursday afternoon traded 17% below its Oct. 9, 2007, price, pays a dividend yield of 3.86%. That's substantially higher than the 3.21% yield on a 10-year Treasury.
- Risk in the stock market isn't by any means absent, but I'd argue that an investor in dividend stocks is getting paid more for that risk than an investor in high-yield bonds is right now. PepsiCo (PEP, news, msgs), for example, is still 12% below its Oct. 9, 2007, price. It has raised its quarterly dividend to 45 cents a share from 37.5 cents during that two-year period. And if you're willing to hold PepsiCo's stock for something like the three years that will pass before the D.R. Horton note matures, you stand a very good chance of seeing your capital appreciate. At the very least, the investor who holds the stock isn't locked in to the 4.25% haircut that holding the D.R. Horton bond to maturity guarantees.
- Dividend stocks offer you some protection against rising interest rates. If interest rates are going up because the economy is in full recovery and is growing strongly enough for the Federal Reserve to try to claw back some of its interest rate cuts, companies' earnings are likely to be climbing. So they'll have the money to raise dividend payouts. Rising earnings should also push up stock prices. The combination gives you a good chance to stay ahead of rising interest rates.
Now that all that's said and done, how did the portfolio do?
I made the first investment in this portfolio on Dec. 6, 2005. I didn't get up to a full 10 stocks until April 8, 2008. I built the portfolio starting with a hypothetical $100,000 and put $10,000 into each of the 10 stocks I picked.
Video: Positioning your portfolio
As of Oct. 6, 2009, that $100,000 in capital was worth $98,891, for a loss of capital of 1.1%.
During that same period, the 10 stocks in this portfolio produced $18,166 in dividends. (No dividends were reinvested but instead accumulated as cash.) That's an 18% return on that initial $100,000 investment.
Looking at both the capital loss and the dividends, the total value of the portfolio of $117,007. That's roughly a 17% total return over 46 months.
For a little context, the return on the S&P 500 from Dec. 6, 2005, to Oct. 6, 2009, was a loss of 17%.
If I turn that $18,166 in dividends into a simple annual rate of return (as opposed to a compounded rate of return, because I didn't reinvest my dividends) that comes to a yield of roughly 4.53%.
That's better than a poke in the eye with a sharp stick, but I think I can do better. In fact, you don't have to look too closely to see some of the problems.
Continued: The 10 stocks in the final portfolio
