Don't Dismiss Dividends

 | Jul 10, 2012 | 1:30 PM EDT
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Cash instruments essentially have a zero, if not negative, real rate of return. And while it may seem that the Fed's zero rate policy is creating a deflationary environment, inflation is occurring where it matters most. Food costs are significantly higher than they were five years ago. At a minimum, cash instruments will continue to deliver negative real returns for the next 12 to 18 months.

As for bonds, the risk is even greater. The idea that risk can be mitigated by owning a fixed-income instrument that locks your rate of return for three, five or 10 years at a maximum return of 1.5% on the 10-year bond simply seems dangerous. Odds are incredibly high that the purchasing power of the U.S. dollar will decline over the next 10 years, so laying out $1,000 today will be worth a lot less in real terms five or 10 years from now. And that's before accounting for the added risk of higher interest rates (which causes bond prices to drop).

If carefully chosen, common stocks can provide fantastic yields -- increased earnings power in an inflationary scenario suggests dividend hikes and stock price gains. What's different today is the historically wide gap between dividend yields and alternative yields.

Let's start with the easy layup, Microsoft (MSFT), which, in my opinion, is a safer investment (with respect to capital preservation) than a U.S. Treasury instrument. Plus, you get 2.7% of your investment back in cash each year. And with $40 billion in net cash, Microsoft could report no profit for over 10 years and still have plenty of cash to pay its dividend. And despite Microsoft's massive size, its 80%-plus market share makes the company a perennial cash cow.

Solid dividends coming from Europe are just as attractive in my book, and Vivendi's (VIVHY:OTC) 6%-plus yield is all the more incredible given the fact that shares are ridiculously cheap at $18 a share. By my account, shares are truly worth closer to $30.

Big dividends can also come from small packages. Small-cap Ark Restaurant (ARKR) serves up a near-7% yield. The company owns a collection of trendy restaurants in food meccas such as New York City, Las Vegas and Washington, D.C. Shareholders have been enjoying this rich payout for years, and the shares have held up nicely as well.

Today's dividends are too good to be dismissed in this environment. Dividends, when coupled with attractively priced stocks, offer investors the best chance of beating market returns.

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