These Dividend Stocks Are Better Than Bonds

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Bonds were rallying on Wednesday after the last meeting from the Federal Reserve signaled that “exceptionally low” interest rates are not going away anytime soon. Rising bond prices is the usual market reaction to this kind of dovish announcements from the Fed, but that's not where investors should be putting their money right now. For those with a long term horizon, high quality dividend stocks are a much better alternative.

The Real Meaning of Risk

Treasury bonds have traditionally been considered the “risk free” asset class, meaning that investors believe that the US would never default on its obligations. Like everything else in finance and economics, this is a matter of debate, but even if we take that for granted, default risk is not the only risk assumed when investing.  You can still lose money versus inflation, and you can certainly end up underperforming other assets in the long term.

This seems like a particularly likely scenario for bond investors in the current environment: ten year bonds are yielding less than 1.7%, which is materially below long term average inflation rates in the US, in the area of 3/3.5%.  If – or when- inflation and interest rates start returning to their historical averages, treasury bonds could suffer some serious losses.

High Quality Consumer Staples

Compare that with buying shares of Coca-Cola (NYSE: KO), for example. Coke is yielding 2.7% in dividends, which means a much better yield, even considering different tax implications for dividends versus bond income. Stocks can be more volatile than bonds, but short term price fluctuations shouldn't be a big concern for long term investors.

Besides, from a fundamental perspective, Coke has some very attractive characteristics. This is a truly global company with one of the most valuable brands on the planet and a rock solid distribution network which would be very hard for competitors to replicate. Coke has increased its dividends on a regular basis for 50 consecutive years, which is an outstanding sign of resiliency during all kind of economic conditions.

A similar case can be made for Coke's biggest competitor PepsiCo (NYSE: PEP), which yields a higher dividend yield of 3.1%. Pepsi has lost market share versus Coke in the carbonated drinks market over the last years, but the company has an indestructible market position in the global snacks market, which generates plenty of profitability for Pepsi.

Pepsi has been focusing on developing healthy food and drink products, and this strategy hasn't delivered the expected financial results so far.  But the company's management has made an innovative and forward looking decision with this move; they are trying to anticipate changing consumer trends, which is a smart approach to the business. The firm has a strong balance sheet and an extraordinary track record of cash flow generation, so it will probably keep raising dividends for a long time.

Procter & Gamble (NYSE: PG) sells every day necessities, and that makes the company especially resilient to economic fluctuations. Tide, Charmin, Pantene, Cover Girl, Pampers, Gillette, Eukanuba, Pringles, Crest, Oral-B, Ariel and Duracell are some of the brands owned by P&G. The company has a strong market position in different product lines, and a very healthy degree of geographical diversification.

P&G is implementing a restructuring program to reduce costs and reinvigorate product innovation, and management expressed during the last earnings press conference that growth is expected to accelerate over the next quarters. Procter yields 3.6% in dividends, and has consecutively increased payments for 36 years, so the company is a safe bet for investors looking for big and growing dividends.

A Diversified Approach to Dividend Stocks

For investors who don't want to assume company specific risk, ETFs can be a great approach for dividend investing. In this way you can invest in a basket of companies with attractive yields at efficiently low costs, which reduces risks while still delivering attractive dividends.

iShares Dow Jones Select Dividend (NYSEMKT: DVY) pays a 3.5% dividend yield and has a portfolio comprised of 100 large dividend companies, mostly in defensive sectors like utilities and consumer staples. No matter what the economy does, diversification in terms of economic sectors and specific names is a fantastic tool for risk reduction, and the ETF charges a moderate 0.4% in annual expenses for this convenient benefit.

Vanguard Dividend Appreciation (NYSEMKT: VIG) follows a different approach to dividend investing; it holds companies with rock track records of rising payments. This means a lower dividend yield, but better portfolio quality and higher probabilities of capital appreciation in the long term. This ETF pays a 2% dividend yield and charges an extremely low annual expense of 0.13%.

Bottom Line

Ultra low interest rates can be bullish for bond prices in the short term. But in the current scenario, long term investors can achieve much better results by focusing instead on high quality dividend stocks. Fortunately, there are many interesting alternatives, both among individual stocks and ETFs.

acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of PepsiCo. Motley Fool newsletter services recommend The Coca-Cola Company, PepsiCo, and The Procter & Gamble Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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