What You Need to Know About Dividends

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

When it comes to stock investing, conventional thinking dictates that returns are all about capital appreciation. However, for many investors, price appreciation may not be the main driver of total return at all. In fact, dividends can constitute a larger portion of total returns than many people may realize.

Dividends Overlooked

According to Loomis Sayles, almost 50% of the S&P 500's total return has come from dividends (when reinvested) since 1929. Blackrock estimates that up to 90% of the S&P 500's total return over the past century can be attributed to the combination of dividends (reinvested) and dividend growth. Whether it's 50% or 90%, the point is that stock returns may really be all about dividends.

Dividends are easy to overlook in the wake of a 150% stock market rally. However, market prices aren't persistent, and during a correction, dividends may be the only positive return around. In addition, high-quality companies with stable, generous dividend yields tend to hold up better in difficult times. With that in mind, here are a few names to look at.

Have Your Cake With Intel

Intel (NASDAQ: INTC) is a $113 billion technology company based in the US, making microprocessors for the computing industry. Over the years, you've probably seen their "Intel Inside" or "Inspired by Intel" logos on a wide range of personal computers and laptops. 

Financially, Intel looks strong. As of its most recent balance sheet, it had about $15.8 billion in total debt against $34.5 billion in current assets, $12 billion of which was cash. In addition, Intel has posted 10 straight years of positive earnings and cash flow.

Over the past decade, the company has generated average annual earnings growth of 16.5%, and delivered double-digit ROE every year. All this makes Intel look like a tech-growth-stock poster child -- not the type of company known for dividends. Yet Intel currently yields 3.90%. That's like having your growth cake and eating the dividends, too.

Chevron While You Wait

Chevron  (NYSE: CVX) is a $250 billion integrated oil and gas company based in the US. It's engaged in everything from exploration and mining of oil to refining and marketing of petroleum products.

While big oil is often associated with companies that are old, mature, and boring, Chevron's actually been quite an exciting story. For example, it's delivered an average annual earnings growth rate of 38% over the past decade. Over the same period, it's stock price is up over 250%. Meanwhile, the S&P 500 has only returned 22%.

 Financially, Chevron looks strong as well. Based on it's most recent balance sheet, the company has $5 billion in debt against $23 billion in current assets, $9 billion of which is cash. Earnings and cash flow have been positive for 10 years in a row and, the ROE has been double digits year year.

Sure, alternative energy poses an obvious long-term threat to the oil industry. That being said, I wouldn't hold my breath waiting for wind farms to take over big oil anytime soon. If you must, then consider holding onto Chevron while you wait. At least it'll pay you 3.10% in annual dividends for your time.

The Show Goes on at Eli Lilly

Eli Lilly (NYSE: LLY) is a $59 billion drug manufacturer based in the US. It's one of the leading pharmaceutical companies in the world, and the company's deep commitment to research and development sets it apart from its peers. Though all pharma companies must engage in R&D, Eli spends an average of 22% of revenues on R&D. That's much higher than the industry average of about 15% and it's also why we can credit Eli with well-known drugs like Prozac and Cialis. 

Financially, Eli Lilly looks healthy. As of its latest balance sheet, Eli has $21 billion in debt against $50 billion in current assets. The company has delivered 10 years of positive earnings and cash flow. While Eli's 10-year average annual earnings growth rate of 3.8% isn't high, it's in line with industry averages. In addition, the company has posted double-digit ROE for the past seven years.

One concern for pharma companies is competition from generic drug manufacturers after drug patents expire. However, this certainly isn't Eli's first rodeo. The company has a long history of developing new, innovative drugs that refresh its portfolio and patent protections. There's no reason to assume that Eli won't keep the show going in the foreseeable future.

The Bottom Line

A high dividend by itself isn't enough. In addition, you should make sure the companies you buy are financially healthy, growing earnings and cash flow, and able to sustain their dividend yields. Among the short list of names in this post, I like Chevron the most.

First, it's engaged in a crucial natural resource which I think has plenty of upside.

Second, Chevron is in the best financial health. Its debt-to-equity ratio of 0.09 is significantly lower than its industry's average (0.23), and is also lower than Intel's and Eli's (0.25 and 0.35, respectively).

Third, it's dividend payout ratio is the lowest, currently only 10%. Intel and Eli have payout ratios of 40% and 50%, respectively. The average for the S&P 500 is about 30%.

Whether Chevron is a good pick or not, keep in mind that individual companies are bound to have surprises, so it's good practice to hold multiple positions instead of concentrating in a single high-yielding stock. Whatever you decide, just be sure to take positions in moderation and as part of a properly diversified portfolio appropriate for your circumstances. 

Victor Lai is an investment adviser representative with Bellwether Capital Management LLC, a registered investment adviser. Victor Lai does not own any positions in the securities referenced in this posting. Clients of Bellwether Capital Management LLC may own positions in the securities referenced in this post.  This post is for informational purposes only and does not represent advice.

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