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Last year, investing for dividends seemed to be all the rage. I read and heard a lot about investors substituting bonds with the stocks of companies expected to be 'recession proof' or companies that would supposedly pay out ever-higher amounts in dividends. At the same time, it was often argued that because investors would be purchasing stocks instead of bonds, the amount invested would surely grow over time as the stock market does what history says it must do: Go higher. As the stock market goes higher over time, dragging along the popular dividend-paying, 'recession proof' stocks, investors would have ever-growing unrealized capital gains on their equity positions. Furthermore, companies would continue raising dividends, thereby sending investors' yield on cost to untold heights.

Yes, this was the story the pundits told over and over last year. Apparently, this panacea for the low yield environment we live in today is right in front of our noses. All we have to do is place that "buy" order and everything will be peachy. The pot at the end of the rainbow is apparently not filled with gold (up double digits year-to-date) but with dividend-paying, 'recession proof', 'bond substitute' stocks.

Everyone has different reasons for purchasing equities, and I am by no means implying that all equity owners of the companies I will mention in this article subscribe to the story mentioned above. Also, I would like to note that I too own some of the popular stocks I will later mention and I certainly hope the story I just described comes true. However, I recognize that hope is not an investment strategy. Therefore, I routinely check in on my stocks to make sure they are performing in the way I expect them to perform.

Recently, I did an analysis of the performance of each of the more than 30 stocks in my equity portfolio. I wanted to know how they were each performing year-to-date. I noticed that some of my highest yielding equities have been the worst performers since the beginning of 2012, so I decided to check on other popular 'recession proof' and/or higher yielding stocks to see if they too were underperforming. Here is a table outlining the year-to-date performance of 11 such stocks. For comparison purposes, I also include the performance of the S&P 500 (NYSEARCA:SPY), Dow Jones Industrial Average (NYSEARCA:DIA), and two popular bond ETFs, the HYG (non-investment grade) and LQD (investment grade). The performance for all securities and indices excludes any distributions (just capital appreciation). Although, even when taking into account what I will call accrued expected dividends (YTD prorated amount), the underperformance is still quite striking. Take a look:

Company

12/30/2011 Closing Price

2/8/2012 Closing Price

YTD Performance

Procter & Gamble (NYSE:PG)

$66.71

$63.64

-4.60%

Johnson & Johnson (NYSE:JNJ)

$65.58

$65.24

-0.52%

Bristol-Myers Squibb (NYSE:BMY)

$35.24

$32.08

-8.97%

Pepsico (NYSE:PEP)

$66.35

$66.74

0.59%

Clorox (NYSE:CLX)

$66.56

$68.38

2.73%

Coca-Cola (NYSE:KO)

$69.97

$68.33

-2.34%

AT&T (NYSE:T)

$30.24

$30.02

-0.73%

Verizon (NYSE:VZ)

$40.12

$37.92

-5.48%

Colgate-Palmolive (NYSE:CL)

$92.39

$91.47

-1.00%

Kimberly-Clark (NYSE:KMB)

$73.56

$71.70

-2.53%

McDonald's (NYSE:MCD)

$100.33

$100.05

-0.28%

S&P 500

1,257.60

1,349.96

7.34%

Dow Jones Industrial Average

12,217.56

12,883.95

5.45%

iShares iBoxx $ High-Yield Corporate Bond Fund (NYSEARCA:HYG)

$89.43

$91.00

1.76%

iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSEARCA:LQD)

$113.76

$116.54

2.44%

Before we go any further, I would like to note that not all securities deemed 'recession proof' or 'bond substitutes' are performing poorly year-to-date. Furthermore, not all of the underperformers made it into the above table (utilities, for instance, are also struggling in 2012). However, all 11 of the stocks in this list are underperforming the S&P 500 and the Dow Jones Industrial Average so far in 2012. In fact, on just a capital appreciation basis alone, 10 of the 11 are underperforming both the HYG and the LQD. Remember that these are the bond ETFs. Furthermore, nine of the stocks are actually down year-to-date, versus 7.34% and 5.45% gains for the S&P 500 and DJIA respectively.

Each of us is likely to have a slightly different perspective on the performance of the 11 stocks in the table. Here are two takeaways: First, timing your entry points is important (price matters). McDonald's is a good example of this. Its stock performed beautifully in 2011. However, you can't buy it at $75 anymore. What matters going forward is how it will perform from $100 per share. Second, doing serious homework on valuations is important. Do not simply buy a stock because you think the business is recession proof, you like the dividend, and a pundit tells you it's cheap.

If you own any of the stocks shown in the table above because you want the capital appreciation benefits historically associated with equities, you are underperforming the indices so far this year. If you purchased any of the stocks shown in the table above because you think they will be good bond substitutes, you are underperforming even the popular bond ETFs. When it comes to individual bonds, there are several even in the investment grade realm that are crushing the 11 stocks mentioned above so far in 2012 as well as outperforming the major indices.

The year is still young and there is time for these popular equities to gain ground. Perhaps on the next market-wide sell-off, investors will hide out in many of these stocks as they did throughout 2011, thereby allowing each of them to gain ground on the major indices. However, keep the following two things in mind when thinking through the role you would like these stocks to play in your portfolio going forward:

If huge numbers of investors were hiding out in these stocks due to uncertainty about future economic conditions, there may be further underperformance ahead (even when factoring in dividends) should economic data be perceived as improving. This would result from investors continuing to rotate out of these stocks into more cyclical companies. Also, when equities eventually go into a bear market at some point in the future, how well do you think each of these stocks (or any of the ones you own) will survive the margin calls, deleveraging, flight out of equities, and hit to earnings that might result? Despite owning some of these stocks myself, I do not think they will buck the trend in the next cyclical bear market. Instead, I fully expect them to initially be the place investors hide out, and then eventually take a hit towards the latter stages of the bear market.

In closing, I don't need to be reminded of the role that dividends have historically played in equity returns. I am well aware. Perhaps the dividends and perception of safety will carry these stocks as the years go on. But, as I mentioned with regard to McDonald's earlier in the article, what matters most is where these stocks are going from here. We cannot currently buy at the lower prices of the past. We can buy at today's price.

Finally, I am not saying that today's prices on any of the stocks mentioned in this article are cheap or expensive. The market will tell us that going forward. I simply want to point out that buying dividend-paying, 'recession proof', 'bond substitute' type equities is not necessarily a foolproof idea. Only time will tell whether they turn out to be our panacea for the zero-interest-rate environment. In the meantime, don't just believe a stock is cheap because a pundit said so, but instead do your own homework, exercise some patience when purchasing, and most importantly, do not forget that there are other assets worth considering as well.

Source: These Dividend-Paying, 'Recession-Proof,' 'Bond Substitute' Stocks Are Underperforming

Additional disclosure: I am long Pepsico bonds.