Consider dividend-paying stocks as an income stream

Created date

June 28th, 2019

A well-balanced portfolio should include a variety of investment vehicles. One important category, particularly for investors who are retired or close to retirement, is dividend-paying stocks. These stocks can create a reliable alternative income stream for people who are no longer working.

“While pure equity holdings are important in a portfolio, they can only be turned into liquid capital when they are sold off,” says financial planner and investment advisor Patricia Russel (financemarvel.com). “Dividend-paying stocks, on the other hand, will offer regularly scheduled payments that investors can count on.”

Dividends have been responsible for about 44% of the S&P 500’s returns over the past 80 years, according to Robert R. Johnson, Ph.D., a professor of finance at Creighton University in Omaha, Neb., and author of several books about investing. He says dividend-paying stocks are particularly attractive in the current interest rate environment because their consistent cash payouts provide a good alternative to bonds. 

“The advantage to buying a stock that consistently pays a dividend versus a bond is that bond payments are fixed and don’t increase over time,” Johnson says. “Dividend-paying stocks not only have a cash flow, but typically that dividend payment increases markedly over time.”

‘Ruler stocks’

If you’re looking to add some dividend-paying stocks to your portfolio, Johnson says companies that have increased their dividend for many consecutive years tend to be relatively safe choices. 

“Some refer to these as ‘ruler stocks’ because if you laid down a ruler on a graph of dividends over time, the ruler would point to the northeast and most of the points would be very close to the ruler,” he says. “Others refer to these stocks as ‘dividend kings.’”

Johnson offers two prime examples of these so-called ruler stocks: Johnson & Johnson and Genuine Parts Company. Not only has Johnson & Johnson increased its dividend for 57 consecutive years, but the company operates in the medical and consumer products industries, which tend to remain stable regardless of the underlying economic environment. Similarly, Johnson says Genuine Parts Corporation has increased its dividend for 63 consecutive years and is in the “somewhat recession proof” replacement auto parts business. 

Johnson says there are 20 companies that have increased dividends every year for the past 50 years, including household names like 3M, Coca-Cola, Colgate-Palmolive, Hormel Foods, Procter & Gamble, and Tootsie Roll Industries. 

“I think dividend investors should look to these stocks first, as they have truly stood the test of time,” he says. “Simply investing in a stock because it has a high dividend yield is problematic, as some stocks with very large dividend yields are likely to have unsustainable dividend levels—think General Electric.”

Robert Baillieul, head of investment research for IncomeInvestors.com, says retirees should look for dividend-paying stocks that he calls “cash cows”—companies in mature industries that don’t have to invest much in property, plants, and equipment and can therefore pay out most of their profits to investors. Baillieul says Hershey Co., which paid $750 million to investors in combined dividends and stock buybacks in 2018, is a “textbook example” of a cash cow. 

“A chocolate bar costs pennies to make. You sell it for a dollar. And it’s habit-forming,” Baillieul explains. “Because snack food no longer represents a fast-growing industry, Hershey doesn’t need to spend much on new factories. For this reason, the company pays out most of its cash to investors.”

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