Get Paid to Get Protection With Dividends

 | Jan 05, 2012 | 1:30 PM EST  | Comments
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Investors often forget how truly valuable strong dividends are to a portfolio. While the income provided by dividends is by far the biggest reason, quality yields are often viewed very favorably by the markets for various intangible, yet valuable, factors. Big-yield stocks tend to offer another form of insurance for an investment portfolio.

A company that pays out an above-average, yet consistent dividend clearly has a very stable operating business that is generating cash in good days and bad. The market recognizes that and doesn't typically subject the company to the volatility that many other securities will experience in an environment like today. That's one form of insurance. Another way dividends protect you is that they serve as a watchdog on management. Unlike earnings, dividends are cash payments and cannot be manipulated by any sort of accounting tools. As a result, dividends help dissuade management from making dumb acquisitions or taking on projects that may erode a company's value and risk the dividend.

Quality dividends also come from companies that are less likely to experience deterioration in stock price over the long term. A 5% annual dividend or more, as was the case with dry bulk shipping companies, offered no sort of protection or growth when shares declined 75% and dividends were suspended. Just like old-fashioned stock picking, one has to selectively find extraordinary dividends from great businesses. In the world of dividend-paying stocks, few make the cut. But Linn Energy (LINE) does. This oil-and-gas MLP yields more than 7% and the payout has been made without interruption before, during and after the Great Recession. The company hedges production, so it's exposure to energy price volatility is minimized, ensuring that cash flows have a degree of consistency, ensuring the payout. Like the S&P, Linn shares were flat in 2011. But the 7% yield meant investors significantly outperformed the index.

Terra Nitrogen Partners (TNH) is another limited partnership with a yield of 9.2%. Demand for nitrogen fertilizer remains robust and the fact that the price of natural gas, a key ingredient in nitrogen production, remains at low levels makes the sale of nitrogen more profitable. Last year, shares advanced more than 70%, so the yield was icing on the cake. While 2012 returns likely won't be as attractive at 2011, TNH is good for a double-digit gain this year when you factor in the yield.

Despite being one of the world's premier defense companies, Lockheed Martin (LMT) boasts a 5% yield as investors have shrugged off the stock in light of uncertainty over defense spending. At current levels, LMT yield is nearly double that of peers General Dynamics (GD) and Raytheon (RTN). More so, Lockheed, along with the rest of defense industry, is trading at valuations that imply no future growth. Lockheed's yield is good money from a high-quality stock that will likely reward patient investors. While the bulk of Lockheed's revenues do come from the Pentagon, the company continues to grow its revenue base from non-Pentagon sources.

Northwest Corporation (NWE) is an under-the-radar, $2 billion regional utility company serving customers in South Dakota, Montana and Nebraska. This company keeps churning out returns for investors in the form of a 4.5% dividend and a steadily appreciating stock price. The reasons are a very attractive-looking balance sheet for a utility company and operating margins nearing 15%. 

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