Dividend Stocks: Income and Quality

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High dividend stocks were all the rage in 2011 and 2012, as yield-starved investors hunted for income where they could find it.

Yet two of the sectors best known as "high yield" sectors--utilities (XLU) and telecom (XTL)--are on track for a sub-par 2012 (the utilities sector is actually negative for the year). It's not particularly hard to see why. Utilities yield just over 4% as a sector, which is nearly double the yield on the S&P 500 and more than double the yield on the 10-year Treasury. But in terms of cash payout, you're not going to be getting significantly more next year than you did this year. Utilities do grow their dividends over time, but they tend to do so slowly.

Don't get me wrong; I'd prefer to take a basket of utilities stocks, equity risk and all, over most bonds at current yields. The uncertainty of the equities markets beats the virtually guaranteed losses that bond investors face, particularly after inflation.

Yet the yield is only part of the story. Dividends are about more than just current income. They are about quality. Which brings me to my recommendation this week: the Vanguard Dividend Appreciation ETF (NYSE: VIG).

VIG.gif

For a "dividend focused" ETF, VIG yields a relatively puny 2%. But unlike bond coupon payments or slow-growth utilities or telecom stocks, VIG's cash payout will almost certainly be significantly higher in the years ahead.

You see, in order to be a holding of VIG, a company has to have at least ten consecutive years of rising dividends behind it. These are growth stocks, not cash cows for widows and orphans.

Yet at the same time, the holdings are generally high enough quality to be held by widows and orphans. Think about. If you're able to raise your dividend throughout the 2008-2009 meltdown and recession, your company must be bulletproof.

VIG is stuffed full of the highest-quality companies in America; Wal-Mart (NYSE: WMT), Coca-Cola (NYSE:KO) and IBM (NYSE:IBM) are its three largest holdings, to drop a few names. And interestingly enough, utilities and telecom together make up less than 2% of the portfolio.

VIG is not an ETF that I recommend you trade aggressively. VIG--and the stocks that comprise it--is the sort of investment that you should use as the foundation of your core portfolio.

As we start a new year, consider ditching any S&P 500 index funds you might own and replacing them with VIG. And for the developed international allocation of your portfolio, you might consider the PowerShares International Dividend Achievers ETF (NYSE: PID). It's built on the same principles as VIG but covers developed non-U.S. markets.

Disclosures: Sizemore Capital is long VIG, WMT and PID.

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About the Author

Charles Lewis Sizemore, CFA, founder and editor of Macro Trend Investor (formerly The Sizemore Investment Letter), is dedicated to finding superior investments backed by powerful macro trends—before you hear about them on the nightly news or read about them in the newspaper or on the Internet. He has been a frequent guest on Bloomberg TV and Fox Business News, has been quoted in Barron’s Magazine, The Wall Street Journal,and The Washington Post and is a frequent contributor to Forbes Moneybuilder, GuruFocus, MarketWatch and InvestorPlace.com.

Charles is the co-author of Boom or Bust: Understanding and Profiting from a Changing Consumer Economy (iUniverse, 2008); and worked alongside best-selling financial author and economic strategist Harry S. Dent, Jr. in creating original research on the effects of changing global demographics on asset returns and economic growth. He also serves as the Chief Investment Officer of Sizemore Capital Management LLC,  a registered investment advisor.

His academic and real-life experience has given him a unique approach to investing: combining his insights into global macro trends with in-depth investor research. And he has developed a reputation for taking complex issues, recognizing long-term investment strategies, and then finding the hidden investing opportunities that he shares with investors.

Charles holds a master’s degree in Finance and Accounting from the London School of Economics in the United Kingdom and a Bachelor of Business Administration in Finance with an International Emphasis from Texas Christian University in Fort Worth, Texas, where he graduated Magna Cum Laude and as a Phi Beta Kappa scholar.

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