Dividend Stocks: How to Soften the Bear's Short-Term Bite

For investors, May started out as a month of great promise. On May 1, the Dow Jones Industrial Average climbed 65.69 points, closing at 13,279.

Since then, however, that promise has turned to plummet.

The Dow posted losses on 12 of the next 14 trading days, culminating with a drop of 46 points last Friday. In all, since May 1, the Dow has lost 6.17%.

But did you know there was a way you could have avoided the bulk of the damage?

All you had to do was hold the dividend stocks in the 30-stock DJIA that offer the highest current yield.

In fact, numerous academic studies have verified the impressive contribution of dividend stocks to long-term market performance. According to certain studies, dividend yields have been responsible for as much as 90% of stock returns over the past century.

And Standard & Poor's reported last year that the dividend component was "responsible for 44% of the total return" of the S&P 500 over the 80 years from 1930 through 2010.

That is quite impressive considering nearly a third of S&P stocks don't even pay a dividend.

Dividend Stocks and Downturns

However, what these studies don't show is just how effective dividends can be in cushioning the impact of a short-term decline in stocks - both in terms of resisting downward price pressure and offsetting capital losses.

So, let's look at some numbers from this month as the Dow Jones Industrial Average as a whole fell 836.83 points, or 6.30%, from May 1 to May 17.

Keep in mind, of course, that they're not based on a scientific study, but rather casual observation.

What you'll learn may make you see dividend stocks in a different light.

During the recent slide, the 10 Dow stocks offering the highest dividend yield on May 1 lost just 3.91% of their combined value during that same period.

To be precise, those 10 stocks had a combined (unweighted) price of $535.94 at the May 1 close, and offered a total annual dividend payout of $19.36 a share, providing a yield of 3.61%.

By the close May 17, the combined price of those same 10 stocks had fallen just $20.98, to $514.96 (which pushed the yield up to 3.76%).

What's more, three of those 10 stocks actually rose in price during the broad market sell-off:

  • AT&T Inc. (NYSE: T), with a dividend of $1.76 for a yield of 5.28%, edged up from $33.06 to $33.29.
  • Verizon Communications Inc. (NYSE: VZ), with a dividend of $2.00 and a yield of 4.93%, climbed from $40.56 to $41.37.
  • The Procter & Gamble Co. (NYSE: PG), with a dividend of $2.25 and a yield of 3.54%, rose from $63.57 to $63.96.

By contrast, the 10 Dow stocks offering the lowest dividend yield on May 1 lost 8.45% of their combined value, more than 2 percentage points worse than the DJIA as a whole - and nearly 5% more than the high yielders.

Specifically, those 10 stocks had a combined price of $607.87 at the close May 1, and offered a total annual dividend of $10.56, for an average yield of just 1.73%. By the end of the day on May 17, the combined price of the low yielders had dropped $51.36 to just $556.51.

Only one of those stocks - The Walt Disney Co. (NYSE: DIS) - managed a small gain, rising from $43.79 to $44.33.

Dividend Stocks Ease Losses

To further accent the value of dividends, consider just one more thing:

If the year ended right now, with no further price moves, the $19.36 in dividends paid out by the 10 top-yielding Dow companies would offset all but $1.62 of the capital loss suffered by investors holding them - meaning their negative return would be just 0.3% of the May 1 value.

Under the same circumstances, investors holding the 10 lowest-yielding Dow stocks would have received just $10.56 in dividends to counter their $51.36 decline in share value, giving them a net loss of $40.80 - and a negative return of 6.71%.

I'd also be willing to bet the differences in return between high- and low- (or no) dividend payers would be even greater among S&P 500 stocks, and truly substantial on the Nasdaq, which has the lowest percentage of dividend-paying companies.

Of course, there's no guarantee these differences will hold up in the next sharp short-term pullback, but the numbers do make one thing extremely clear:

Dividend stocks offer far more to investors than just a modest quarterly check - both defensively and in terms of net total return.

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