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By Jeremy Glaser | 01-07-2011 11:42 AM

What a Recovery in 2011 Means for Dividend Stocks

Morningstar's Josh Peters looks at how dividend stocks may perform in 2011 and offers up one of his favorite stock picks for the new year.

Jeremy Glaser: For, I'm Jeremy Glaser. I'm here today with Josh Peters. He is Editor of Morningstar Dividend Investor. We're going to take a look at what a recovery in 2011 could mean for dividend stocks.

Josh, thanks for joining me.

Josh Peters: Good to be here Jeremy. Happy New Year to you.

Glaser: Thank you very much. Let's take a quick look back at 2010, maybe the recovery kind of had fits and starts throughout the year, how did dividend stocks perform over the last 12 months?

Peters: I think best place to start to just have a reference point the S&P 500 did 15.1% on a total return basis including reinvestment of the dividends paid by those companies. Some of the dividend indexes that I look at like the Dow Jones Select Dividend Index, Morningstar's own Dividend Leaders Index which are geared more towards just higher yielding stocks, did a little bit better couple of percentage points better than that.

The two modeled portfolios that I manage is actually kind of an interesting divergence. The Harvest Portfolio which is really designed to try to maximize yield while still getting good growth and good overall total return did 28% which really surprised me on the upside, very pleased with that result.

People were looking for yield as interest rates continued to stay low but we also saw a resumption of dividend growth for some of our holdings especially from the master limited partnerships that we owned. The Builder side which has lower yielding stocks actually more cyclical exposure and over the long run where we think more dividend growth. It actually lagged the market a little bit did 14.4%.

So, overall I think it was a decent year for our recommendations somewhere fell a little bit short. Abbott Labs and Johnson & Johnson two healthcare stocks I like very much, I think still very good dividend growth prospects. They really weighed on our performance at the bottom end but dividend yield really had a lot to deliver not just in terms of income but also capital appreciation last year.

Glaser: What's your expectation for the economy in 2011 then?

Peters: Well, I'm not really sure and actually that's the question I try not to ask at least as any specific year or quarter or monthly employment report or something like that is concerned. It's very hard I think to make a forecast that once we'll be accurate and then to derive investment conclusions directly from that because there is always a center play between the uncertainties around the forecast what are our expectations what's built into prices.

By the time that forecast becomes a report, even if you're right, the market is going to be looking that much further ahead. So, I really try to stay out of that guessing game. Instead what I try to do is just think what are the downside risks and then manage them. If the recovery falters again and we really have a slog of say very low GDP growth in 2011, I think the kind of companies that I have bought with high yields and the ability to continue growing their dividends under stress, under some economic stress, that those will be very rewarding companies to own.

If the economy really takes off and proves that this wasn't already discounted in the rally that we've had here since the summer, then probably going to fall behind on a relative basis. I think our portfolios still do well in that situation, but maybe not as much as the S&P 500 or the more speculative sectors of the market.

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