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Dividend Stocks: How To Profit From The World's Best Investment Protection

Do you know what the ultimate investment protection is?

It's not gold, and it's certainly not Treasuries.

It's dividend stocks.

Companies that pay consistent dividends are in better fiscal shape than the U.S. government, and the payouts significantly outpace those of Treasuries. The advantage over gold of course is that the yellow metal yields nothing – it's simply a store of value.

And yet dividend stocks also protect against inflation, since profits for the companies behind them tend to rise alongside prices.

To understand the advantages dividends can provide an investor during a down market, just look at the implosion of the dot-com bubble in 2000.

According to Morningstar research, the Standard & Poor's 500 Index lost 9%, while dividend-oriented mutual funds – including high-yielding stocks in the financial-services, mutual-fund and real-estate sectors – gained anywhere from 10% to 30%.

And I shouldn't need to remind you that dividends account for the majority of the stock market's returns.

A study by Yale economist Robert Shiller showed that in the 109 years from 1889 to 1998, the average real return on common stocks was 7%, of which 4.7% was represented by dividends.

While stock prices have been plunging, dividend payments are rising. Through Aug. 31, 243 companies in the Standard and Poor's 500 Index increased or initiated a dividend payment. In fact, dividend payments are expected to end 2011 up 18% from 2010.

That's the case for dividend stocks. Now I'm going to give you some potent investment ideas to help you get on board (Learn how to find a 9.15% dividend stock in our latest special presentation right here.).

Investing in Dividend Stocks

Generally speaking, there are two types of dividend stocks. There are large blue chips, which have a reliable but modest payout. And then there are the obscure companies, which have a higher yield but less safety.

In the first set you'll find companies like The Procter & Gamble Co. (NYSE: PG) with a dividend yield of 3.4%, PepsiCo Inc. (NYSE: PEP) (3.4%), Johnson & Johnson (NYSE: JNJ) (3.6%) or, at the slightly riskier level, Altria Group Inc. (NYSE: MO) with a yield of 6.2%.

All of these companies yield more than Treasuries. Plus, they have the added bonuses of being safer than sovereign debt and less vulnerable to inflation.

If inflation runs at even 10% for a few years, these companies' profits will rise more or less in tandem with prices. So will the value of their assets and businesses. If there's a big stock market crash, the price of these solid companies will decline – but even then, probably less than the market as a whole. And if the dollar crashes, you're MUCH safer in these companies than in Treasuries, because a large proportion of their profits come from outside the United States.

The second set of dividend stocks is where you'll find the riskier high flyers – smaller companies whose dividend yields are above 7% to 8%.

This second group has two advantages: First, the dividend yield itself is far above that available on bonds with any degree of safety. And second, if the companies themselves have solid operations, particularly if there is any kind of growth in earnings, a nice capital gain will accompany the juicy dividend.

Here's an example. My Permanent Wealth Investor service bought shares in B&G Foods Inc. (NYSE: BGS). B&G is in the business of buying tired food brands that are peripheral to big companies' operations (they own Cream of Wheat, for example) and rejuvenating them through active marketing and promotion.

At the time of our purchase, the stock was yielding 7.2%. B&G flourished over the next 18 months. The company's earnings were so robust that it increased the quarterly dividend by 23%. That success brought new investors, driving the stock price higher. Now it's trading at about double what we paid. The stock's yield has dropped as a result of the higher price but only for investors who are just getting in now. And a yield of about 5% is still well above the S&P 500.

Essentially B&G has moved from the second category of high yield stocks to the first; it is now priced as a company with solid operations, some growth and an attractive dividend yield. And even at its current valuation, it is by no means overpriced.

Take Aim at "Alpha Bulldogs" for Investment Protection

Companies like B&G are what I like to call "Alpha Bulldogs." These are companies whose dividend is solid, maintainable, and covered by earnings.

By no means are all high-dividend stocks Alpha Bulldogs. In the financial sector, there are a number of companies that are taking advantage of the Federal Reserve's irresponsible interest rate policy by borrowing short-term and investing in long-term mortgage bonds.

This will give them a very juicy return – until interest rates go up sharply, at which time their borrowing costs may exceed their investment yield and the capital value of their portfolio will collapse.

Outside the financial sector, a number of high dividend stocks pay out more than they earn, or have earnings with a strictly finite life. These companies are essentially cannibalizing capital to pay dividends – not an attractive investment.

We call these companies, which appear attractive but are in reality dangerous "Mangy Curs."

That said, I have one more recommendation for you – an Alpha Bulldog. It is currently trading at an attractive price and yields more than 9%. And you can learn more about it with our latest special presentation from Money Morning Private Briefing. You'll also get some of the best of my high-priced trading service recommendations for less than the cost of a pint of decent beer. Just go here to learn more.

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