Finance Over the last several years, dividend stocks have become an important tool that is helping investors to realize above average returns. According to Paul (2012), these areas have been accounting for 40% of profits on the Dow Jones Industrial Average since 1930. This is because they can provide a number of benefits in assisting investors to realize their long-term objectives with him saying, "Those areas that offer sustainable and growing dividends hedge income streams against inflation, to provide growing income to investors without the need to sell shares and to signify strength to investors. These firms generally exhibit lower stock price volatility, while delivering attractive and even superior returns." This is illustrating how these kinds of securities can provide protection, lower amounts of volatility and higher returns to investors. (Paul, 2012)

In 2012, these returns have been greater for those companies in contrast with growth areas (such as the Russell 2000). The below table is comparing these returns with the dividends that were received from the firms listed on the Dow Jones Industrial Average (which paid dividends).

Russell 2000 Growth Companies vs. The Dividends Paid on the Median Return for Dow Jones Industrial Average Dividend Stocks

Index

2012 Return

Dow Jones Industrial Average Dividend Stocks Performance and Income

10.0%

Russell 2000

9.58%

("Russell,"2012) (Arends, 2012)

These figures are illustrating how the total returns are higher in contrast with companies that are focused on growth (which pay no dividends).

Introduction

A common challenge that all investors will face is finding asset classes that can reduce their risk, increase income and offer capital appreciation. Those companies that are paying dividends are considered to be more established and they have track record of delivering consistent earnings. As a result, the different corporations with the highest yields on Dow Jones Industrial Average include: AT&T, Verizon, Intel, Hewlett Packard, Du Pont and Merck. These firms are paying between: 3.79% to 5.24%. ("Dow Jones Industrial Best Dividend Stocks," 2012) Moreover, they are yielding an average return of 10% for 2012. (Arends, 2012)

When this is compared with other investment classes, these figures are much greater. Evidence of this can be seen in the below table (which is contrasting the average divided growth rate with certificates of deposit and U.S. Treasuries).

Return of Dow Jones Industrial Average Dividend Stocks in Contrast with CDs and U.S. Treasuries

Category

Return

Dow Jones Industrial Average Dividend Stocks

10.0%

CDs

2.35%

US Treasuries

2.68%

Corporate Bonds

4.68%

(Arends, 2012) ("Current Rates," 2012)

These numbers are showing how dividend stocks are providing a larger return in comparison with other asset classes. For investors, this is illustrating how they have fewer opportunities to receive consistent amounts of income without increasing the risks exponentially. To fully understand what is taking place, there will be a focus on: dividend paying firms in comparison with other areas, top performing dividend industries, the weaker dividend sectors and if a bubble is developing in these securities. Together, these elements will highlight if the value of these stocks are inflated in contrast with their fundamentals.

Dividend Paying Stocks in Contrast with Other Popular Investments

The biggest reason why dividend paying stocks have risen in popularity is because interest rates are sitting at historical lows. This is because the economy has been facing considerable challenges and the Federal Reserve is trying to stimulate growth by reducing them to such levels. For investors who are purchasing CDs, this is problematic as they will be unable to receive a positive return (when taxes and inflation are taken into account). (Stein, 2005)

Evidence of this can be seen by looking at the yield on CDs. In 2002, everyone could earn interest of 6.20% on these investments. As the economy collapsed, many of the yields were steadily declining to prevent it from falling into a depression. During this process, is when the total returns in these areas decreased to the point that many investors were realizing negative returns (with them sitting at 2.35%). (Stein, 2005) ("Current Rates," 2012)

For retires and individuals that wanted to have increased amounts of income, they began to invest in Dow stocks (which paid more than what they were receiving in CDs). This meant that their focus shifted from purchasing these areas to those companies which could offer higher yields and growth. Evidence of this can be seen with observations from Carrel (2010). He found that there are several major advantages of investing in dividend stocks to include: passive income, improved total returns, reduced risks (from purchasing more stable companies) and continued ownership while collecting profits. This is significant, in illustrating how this asset class has become more popular based upon: the low interest rates, reduced risk and the ability to realize a larger return. As a result, investors have been focused on locating assets classes that can provide them greater returns without increasing the overall amounts of risk. Dividend stocks are one of the highest yielding areas that can achieve these objectives. (Carrel, 2010) (Stein, 2005)

At the same time, the yield on U.S. Treasuries is sitting at 2.68% and investment grade corporate bonds are 4.68%. In the case of U.S. Treasuries, these amounts are similar to what is provided with CDs. This means that investors will receive negative returns in this asset...

(Stein, 2005) ("Current Rates," 2012)
While corporate bonds, are paying higher amounts of interest. However, the risks increase exponentially based upon the potential that the firm will default. In those situations where the corporation has a higher rating for credit worthiness; the yields will be closer to what is offered by U.S. Treasuries. This is illustrating how these investments pay a little bit more. Yet, they do not offer the same kind of potential returns as divided stocks. These factors are showing how investors want something that will offer them with the best returns and the least amounts of risk. In order to achieve these objectives, they have been turning to this asset class as a way to enhance their performance and reduce volatility. At the end of the year, this will provide them with more balance, diversification and a greater total return. (Stein, 2005) ("Current Rates," 2012)

Another area that could be considered is fixed annuities. These are insurance contracts that can provide investors with a guaranteed return that is not tied to the stock market. In general, the problem with investing in this asset class is they are illiquid with various stipulations (such as: surrender charges over a select period of time). This can hurt their return and ability to have access to the money. For many investors; dividend stocks offer greater yields, larger returns and more liquidity. (Petcher, 2011) These factors are highlighting why many individuals are turning to these kinds of securities and the reasons they have become so popular in the last few years.

Top Dividend Performing Industries

There are many different industries that are considered to be the highest dividend payers with the lowest amounts of risk. Looking at the stocks listed on the Dow Jones Industrial Average there are a number of sectors that fall into a host of categories. The below table is highlighting the different companies with the largest yields in contrast with their industries.

Dow Stocks with the Greatest Dividends and their Industries

Company

Yield

Industry

AT&T

5.24%

Telecommunication

Verizon

4.71%

Telecommunication

Intel

4.56%

Technology

Hewlett Packard

4.24%

Technology

Du Pont

3.99%

Chemicals

Merck

3.79%

Pharmaceuticals

Pfizer

3.59%

Pharmaceuticals

McDonalds

3.54%

Food Service

Johnson and Johnson

3.51%

Pharmaceuticals

Chevron

3.41%

Oil and Gas

Microsoft

3.32%

Technology

Proctor and Gamble

3.23%

Consumer Durables

GE

3.23%

Industrial Goods

("Dow Jones Industrial Best Dividend Stocks," 2012)

These figures are showing that there are many different sectors which are offering solid dividends and increasing value. The most notable include: technology, oil / gas, industrial goods, pharmaceuticals, consumer durables, food services, chemicals and telecommunications. ("Dow Jones Industrial Best Dividend Stocks," 2012)

However, outside of the Dow Jones Industrial Average are other sectors that will have high yields with low amounts of risk. Most notably, electricity and natural gas distributors / producers are industries that fall into this category (which is illustrated in the below table).

High Yielding Electric Utilities and Natural Gas Distributors

Company

Yield

Industry

Atlantic Power

9.56%

Electricity

Trans Atla Corp.

7.59%

Natural Gas

Exelon

7.35%

Electricity / Natural Gas

Gas Natural

5.84%

Natural Gas

Pepco Holdings

5.65%

Electricity / Natural Gas

Ameren Corp.

5.60%

Electricity / Natural Gas

Unitil Corp.

5.54%

Electricity / Natural Gas

TECO Energy

5.43%

Electricity / Natural Gas

First Energy

5.36%

Electricity

("Utility Common Stocks," 2012)

These figures are showing how electricity and natural gas stocks are providing higher yields to investors with reduced risks. This is because these firms have a commodity that is continually in demand regardless with what is happening with economy. As a result, this means that they have more consistent earnings and can offer investors with greater amounts of appreciation and protection. ("Utility Common Stocks," 2012)

Those firms with rising dividends and solid fundamentals include: technology, oil / gas, industrial goods, pharmaceuticals, consumer durables, food services, chemicals, electricity / natural gas producers as well as telecommunications. This is illustrating how these industries have select firms that can provide investors with reduced amounts of risk and greater appreciation. The higher yields and the potential for greater rewards are what have been leading to more demand. ("Utility Common Stocks," 2012) ("Dow Jones Industrial Best Dividend Stocks," 2012)

Dividend Weaker Performing Industries

However, despite the strong yields and consistent earnings with many dividend stocks, there are select firms that have trouble maintaining these high levels. This is because some companies are using dividends to entice investors to become interested in the firm based upon the large yield…