You Don't Have to Pick a Winner in Dividend Stocks -- Here's Why

I love dividend stocks and pretty much always have. One thing I've learned over my decades of buying them, however, is that often, it is better to look for "losers" than "winners." Some investors don't want to put in the effort that I do, but that's fine. You can still own dividend stocks by purchasing mutual funds and exchange-traded funds (ETFs) that focus on dividend payers.

In other words, there are plenty of options for investing profitably in dividend stocks.

My dividend-buying process, in a nutshell

When I'm looking for what I would dub dividend "losers," I start by looking at lists of companies that have increased their payouts annually for long periods of time. At least 10 years is my minimum, but I prefer if a company's streak of dividend hikes puts it into the Dividend King category (50-plus years). From there, I look for companies with historically high yields, which I believe is an indication of a cheaply priced stock. From this (usually small) list, I select investments that I think have long-term appeal. Often, I don't end up buying anything new when I do a search like this and just stick with the portfolio I already own.

Image source: Getty Images.

Two examples of stocks that I own today and would buy again at current prices are Medtronic (NYSE:MDT) and Hormel (NYSE:HRL). Medtronic is a medical device company and its stock has fallen by roughly a third from its 2021 high. Hormel is a food maker and its stock is down roughly 25% from its 2022 peak. Given the price action, they are both clear "losers" right now. Their weak stock prices, though, have pushed their yields up toward historically high levels.

But, Medtronic has increased its dividend annually for 46 consecutive years and Hormel has hiked its payouts for 57. By coincidence, both had an annualized dividend growth rate over the past decade of 13%. And while each company faces headwinds right now, their still-robust businesses and long histories of success suggest to me that they will find a way to muddle through their problems.

I've found one-time losers like Procter & Gamble and Nucor this very same way, and I'm now sitting on substantial price gains in both stocks. Oh, and I continue to collect dividends with generous yields based on my purchase prices.

MDT data by YCharts.

In other words, you might want to forget the recent winners among dividend stocks and shift your focus to the losers instead if you want to find well-priced dividend payers to buy.

Other choices when dividend shopping

The work of digging into individual stocks isn't for everyone, and that's OK. There are other options for adding dividend payers to your portfolio, including mutual funds and exchange-traded funds. The list of choices is quite long, but here are a few you might want to start with.

The Vanguard Dividend Growth Fund (NASDAQMUTFUND:VDIGX), for example, focuses on "high-quality companies that have both the ability and the commitment to grow their dividends over time." It has a low expense ratio of 0.3%. The problem is that it isn't offering a huge yield, thanks to its focus on dividend growth. Its trailing yield is 1.7%.

Another option is the Vanguard High Dividend Yield Index Fund (NASDAQMUTFUND:VHYAX), which has a 3.1% yield. It has a tiny expense ratio of 0.08% and "provides broad exposure to U.S. companies that are dedicated to consistently paying larger-than-average dividends." While you might argue that 3.1% isn't all that high a yield, keep in mind that pooled investments generally hold a fairly large number of stocks that were all bought at different times. That means that some stocks will have appreciated. Because of this, their current yields will be lower and will drag down the overall yield of the fund when you buy it. This is a basic side effect of outsourcing your income investments, and it is hard to avoid.

What's interesting here, though, is that Vanguard also offers an ETF version of the Vanguard High Dividend Yield Index Fund (NYSEMKT:VYM), which is similar in most ways but has an expense ratio of 0.06%. But that's hardly the only ETF you can buy that focuses on dividend payers. If you'd like to focus on stocks with long histories of dividend increases, you can buy an ETF like the Invesco Dividend Achievers ETF (NASDAQ:PFM), with a yield of 1.8% and an expense ratio of 0.52%. Dividend Achievers have increased their dividends annually for 10 or more years consecutively.

If you prefer just high-yield stocks but don't like the Vanguard option, you could try the SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT:SPYD), which tracks the 80 highest-yielding stocks in the S&P 500 index. It has a yield of 4.7% and a management fee of 0.07%. This ETF is rebalanced regularly, but will likely have material exposure to real estate investment trusts, the financial sector, and utilities -- areas that often have high yields. It is also likely to have a good number of stocks that are out of favor with investors, which generally leads to higher yields.

Choose your fund or ETF wisely

I've thought about buying a dividend-focused mutual fund or ETF, but I have never been ready to pull the trigger. There are just too many trade-offs for me, including that doing so would put me into stocks I wouldn't buy on my own, the low yields you often have to accept given the nature of pooled portfolios, and selection methodologies that just don't sit well with me. (Just buying the highest-yielding stocks or stocks with long track records of dividend increases can have unintended consequences at a portfolio level.)

I see why someone would want to own a dividend-focused mutual fund or ETF, given the ease it offers. And there are plenty of options, but it would be a mistake to simply pick the highest-yielding choice and call it a day. The various options highlighted above are intended to show well-respected options that span the wide variety of choices you have to consider. Make sure what you buy fits well with the type of investor you are at heart, or you may not hold onto the investment long enough to properly benefit from owning it.

That said, I continue to choose buying individual dividend stocks so I can cherry-pick the ones that make the most sense to me. And that, as noted, usually means avoiding "winners" and looking for temporary "losers."

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Reuben Gregg Brewer has positions in Hormel Foods, Medtronic, Nucor, and Procter & Gamble. The Motley Fool has positions in and recommends Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.