3 Reasons To Buy Blue-Chip Dividend Stocks Right Now

Jul.26.12 | About: Vanguard Dividend (VIG)

With market sentiment at incredibly bearish levels and news headlines predicting doom and gloom, it's easy to get scared off. Nonetheless, investors with an eye on the long term should be stockpiling dividend stocks for the following three reasons.

1: Payout Ratio Low (Dividends Will Be Boosted)

One factor that dividend investors pay a lot of attention to is the dividend payout ratio. A ratio that's too high means that dividends might not be increased very quickly, as a lot of cash flow is used up in paying dividends. Luckily, the dividend payout ratio is currently well below historical norms, suggesting that companies have plenty of room to raise their dividends. According to data from Forbes:

The dividend payout ratio... historically has averaged 52%. Today the average is still a very low 32%, suggesting firms have plenty of earnings on hand to keep the increases coming.

2: Superior Yield

Another rare occurrence is the superiority of dividend yields to yield available in Treasury bonds. While long-term Treasury bonds typically provide good coupon payments, due to the "flight to safety," as of right now, many quality dividend stocks give a better yield than even 30-year Treasury bonds. Check out the yields on blue chips Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ), Eli Lilly (NYSE:LLY), and Intel (NASDAQ:INTC) in comparison to the 30-year bond.

Click to enlarge

^TYX ChartClick to enlarge

^TYX data by YCharts

3: Inflation Protection

Many investors are understandably concerned about the threat of inflation. While many people turn to precious metals like gold (NYSEARCA:GLD) or silver (NYSEARCA:SLV), it turns out that over the long term, equities are a much better inflation hedge. Stocks with dividend growth hedge against inflation in several ways:

  1. The dividend payout will counter the effects of inflation, and most likely outperform inflation.
  2. The stock price will adjust to keep up with the dividend, providing further protection from inflation. Take KO, which currently has a $2.04 annual dividend. Assuming conservative 5% annual dividend growth, the dividend payout will be $3.25 in 10 years, $5.30 in 20 years, and $8.64 in 30 years. Do you really think Coke's price will stay flat so that in 30 years, the stock will offer an 11% dividend yield? Highly unlikely.
  3. Reinvested dividends can multiply long-term returns. From January 2001 to January 2011, the S&P 500 actually lost just under 4%—but with reinvested dividends, an investor would have gained 15.8% over that time period.

For these reasons, dividend growing stocks are likely to outperform as the 30-year bond bull market comes to an end. Below is a chart of companies with a history of raising their dividends. Please note that Eli Lilly has not raised the dividend in recent years, but will likely resume regular dividend increases in the future.

LLY Dividend ChartClick to enlarge

LLY Dividend data by YCharts

In conclusion, dividend stocks are a particularly attractive asset class. Investors should be cautious, however, to focus on growth rather than yield, to pick up individual stocks when they're attractively valued, and never to sacrifice quality for yield.

The stocks I mentioned are good starting points, as are the Dividend Aristocrats. Investors who have less capital or prefer one-stop shopping might find that the Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) or the SPDR Dividend ETF (NYSEARCA:SDY) might fit their needs.

Disclosure: I am long INTC, JNJ, LLY, KO, PG, SLV.