Dividend Stocks Will Be Winners for a Whole Decade

BOSTON (TheStreet) -- The dividend trade is crowded, with almost every investor on the hunt for high yields. Wells Fargo analysts, however, say companies may only now be catching on to how investors are selecting stocks based on dividends.

Dividend-paying U.S. shares have been a favorite for investors following a 20% decline in stock market indices late last year. With economic growth expected to plod along and interest rates likely to remain incredibly low, investors have been forced to look for yield and steady income in other places.

In 2012, though, the market has booked the best gains in a quarter century to start the year, led not by dividend stocks but small-cap and speculative companies. Investors, it seems, are comfortable taking on more risk as Europe continues to figure its way out of a massive debt crisis.

Wells Fargo senior analyst Gina Martin Adams took a deeper dive into dividends, which she calls this decade's winning theme. While investor appetite for dividends has never been greater, Adams notes that dividend payouts are actually near record lows. She points out that the dividend payout ratio for the S&P 500 is at 27%, well below the long-term average of 53% and is at the lowest level on record since 1871.

"Companies may be only just beginning to catch on to the fact that investors are keenly interested in dividend paying stocks, for while dividends are increasing, payout ratios are at an all-time low," Adams writes. "Dividends still have plenty of room to grow."

At 2.1%, the dividend yield for the entire S&P 500 rivals the yield of the 10-year U.S. Treasury but remains below the long-term average of 4.5%, Adams notes. While that average yield may seem low, Adams points out that dividends have actually been providing the bulk of the return to shareholders. Since 2001, the S&P 500 has a total return of 26.4%, although the price-only return is just 2.3%.

The slow economic recovery has only benefitted dividend-paying companies. Adams says that, on a rolling monthly basis for the past two years, companies that grew dividends faster than their sector average have outperformed over the following six- and 12-month periods.

"Limited secular growth prospects, given debt deleveraging, combined with demographically driven investor demands seem likely to continue to elevated dividend payer relative performance," Adams adds.

Adams notes that after a combined 140 companies slashed or cut dividends in 2008 and 2009, the recent earnings recovery has aided 256 dividend increases in 2010 and 342 dividend increases in 2011. As a result, dividend breadth is the best in at least a decade.

However, Adams says, dividend increases have paled in comparison to the acceleration in profits. She has come up with three different ways for investors to take part in the dividend delight. These opportunities are highlighted on the following pages, with some of the stock picks that fall under each category.

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