First of all, dividends do matter. According to research from Wharton Professor Jeremy Siegel, reinvested dividends account for as much as 97 percent of total market performance. Better yet, dividends even impact how big your capital gains are. Over the last 36 years, dividend stocks have outperformed the rest of the S&P 500 by 2.5 percent annually, and they outperformed nonpayers by nearly 8 percent every year, all while paying out cash to their shareholders, according to data compiled by Ned Davis Research.
An important question is whether five names will provide the diversification you need from an income portfolio? The short answer is yes. The truth is that you don't need to own hundreds of stocks to create a diversified portfolio—in fact, just five names cut around half of the volatility from a single-stock portfolio. Up it to 1,000 positions and volatility only drops another 10% and change. In short, a small portfolio of dividend stocks you have time stay on top of beats a huge, unwieldy portfolio any day.
With that, here's a look at five must-own dividend stocks for 2013.
Up first is AT&T, the "second largest" wireless carrier in the U.S. with 92 million cellular subscribers. Calling AT&T the No. 2 player is a bit of a misnomer. While the company does have fewer wireless customers than rival Verizon's wireless arm, AT&T's shareholders own 100 percent of its wireless business while Verizon only owns a pro-rata share of a 51-million subscriber business. While wireless may be AT&T's most visible business, the firm also has a huge fixed-line unit, which provides service to 37 million phone customers, 16 million Internet users and 4 million television viewers.
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Ultimately, the telecom business is a relationship business. That's become especially true now that technology advances allow AT&T to compete with more communications companies than ever before. AT&T has been leveraging its relationships to offer triple-play deals that bundle voice, Internet and television services in a single package. Those bundled deals provide AT&T with much larger margins and, in turn, much larger cash flows.
The communications business isn't cheap to operate in. Capital requirements are massive, and the need to spend mountains of cash on infrastructure equipment feels incessant. Even so, AT&T has managed to keep its balance sheet in strong shape while it throws off cash to pay out a hefty dividend. As I write, AT&T's 4.98 percent dividend makes it the top-yielding Dow component.
Drug giant Pfizer is another must-own dividend name for 2013. The $200 billion pharmaceutical firm owns some of the most well known prescription pills on the market today—and despite the threat of patent drop-offs that's been haranguing the whole pharma industry, Pfizer has been showing off its ability to save its bottom line with cost savings and M&A. Right now, this stock pays out a 3.42 percent dividend yield.
In 2009, Pfizer bought drugmaker Wyeth in a deal that dramatically increased the combined firm's drug pipeline while realizing massive merger cost savings. As a result, while Wall Street remains fixated on the negative effects from Lipitor's patent loss, Pfizer is pushing along a slew of phase I, II and III drug candidates that have the potential to reach blockbuster status.
Financially, Pfizer is in stellar shape. The firm boasts a $10 billion net cash position post-merger, on top of Pfizer's already strong cash flow generation abilities. Those factors should help keep the hefty payout from this big pharma firm intact for the foreseeable future. Once investors realize that, there should be some capital gains to go along with it.
It's been a crummy year for semiconductor giant Intel. Shares of the $104 billion chipmaker have slid more than 24 percent in the trailing 12 months, underperforming the S&P 500 by a broad clip. So why is this struggling stock making our list of must-own dividend names now? In short, it's getting ready for a change in trend.
Intel is the biggest name in the chip business, with around 80 percent of the microprocessor market. If you own a computer, there's a 4-in-5 chance that it's powered by an Intel chip. Intel's dominance in the chip business has been hard fought, but now that it's so established, the firm is going to be hard to unseat. Intel effectively owns the computer processor business, and while computers have become extremely commoditized in recent years, Intel's chips haven't.
(Read More: Intel to Launch Online TV Service This Year)
Mobile devices are the biggest path to growth for Intel at this point, in part because they get consumed so quickly and in part because they could steal share from the computer business. Intel's balance sheet is pristine, with around $12 billion in net cash and investments after all of its debt is accounted for. Better still, that steady downtrend in shares has shoved Intel's generous dividend yield to 4.28 percent. As semiconductors stage an about-face in 2013, Intel shareholders should benefit more than most.
Garmin is a bit of an unlikely name on this list. While the other names are staid blue-chip stocks, Garmin's $6.4 billion market capitalization puts it squarely in mid-cap territory. Even so, the special opportunity in this stock is presenting a big buying opportunity for Garmin right now.
Garmin makes global positioning devices for cars, boats, planes and fitness enthusiasts. That exposure to all corners of the GPS market is significant—and it's the sole differentiator that keeps Garmin head and shoulders above peers. It means that Garmin is able to pour R&D into big-ticket electronics (such as the $50,000 G1000 avionics suite for small planes) and then transition the tech to the more margin-sensitive consumer market. The result is net profit margins that consistently scrape up against the 20 percent mark.
In spite of recent successes for Garmin—namely the growth of its innovative fitness offerings in the last two years—investors don't see how this stock can continue to perform at a high level. That's a big part of why Garmin is consistently one of the most heavily shorted mid-cap names on the Nasdaq. A spotless balance sheet with approximately $3 billion in cash and investment and no debt makes Garmin an exciting opportunity this year. As I write, the firm pays out a 5.43 percent dividend yield—the biggest on this list.
You can't build a dividend portfolio without looking at utility stocks—which brings us to PPL.
PPL is a utility stock that owns 11,200 megawatts of generation capacity, and provides regulated utility service to electricity customers in Pennsylvania, Kentucky, Virginia, Tennessee and the UK. PPL also distributes natural gas to Kentucky. Just a few years ago PPL was primarily a generation firm, earning three-fourths of its profits by selling power on the open market. Today, though, the firm has shifted its strategy towards the stable income of the regulated utility business.
Stable, predictable income is the hallmark of a stellar dividend stock, and PPL has managed to pick up its regulated exposure while still keeping its uniqueness. A big differentiator for PPL is its energy distribution unit in the UK—that expertise in a foreign market should open the door to other overseas utility operations if attractive opportunities present themselves down the road.
Dividend growth at PPL is likely to cool in the next couple of years as the firm dumps considerable CapEx into upgrading its infrastructure. That's actually a good thing for dividend investors because it means that PPL's dividend prospects are going to be artificially held down in the near-term. With the firm's payout already at 4.87 percent, investors shouldn't have any trouble waiting a while for the next hike.