How the Dow's Top Dividend-Paying Stocks Have Fared in 2016

By Dan Caplinger Markets Fool.com

Dividend-paying stocks are a great way to combine current income with the prospects for future growth. Many investors looking for the top dividend-paying stocks in the market turn to a strategy known as the Dogs of the Dow to maximize both income and returns. All 30 of the components of the Dow Jones Industrials (DJINDICES: ^DJI) are stocks that pay dividends, but by focusing on some of the top-yielding stocks in the average, you can capture more in dividend payments -- and sometimes produce great returns.

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This year, companies such as Caterpillar (NYSE: CAT), Chevron (NYSE: CVX), and IBM (NYSE: IBM) have a big lead over the overall Dow in terms of total return and dividend yield. Below, we'll look more closely at what these key dividend-payers have done and why they might continue to do well.

Stock

Current Yield

Year-to-Date Return

Caterpillar

3.3%

39%

Chevron

3.8%

26%

IBM

3.5%

16%

Data source: Yahoo! Finance.

A big comeback for hard-hit dividend stocks

One of the fundamental ideas behind looking at high-yielding Dow stocks it that they tend to involve companies that have hit hard times recently. When stock prices fall, dividend yields rise unless the company has to reduce its quarterly payouts. As a result, you can bottom-fish the Dow like a true value investor, picking up shares of suffering companies on the cheap and hoping for them to bounce back. That's exactly what has happened with these three dividend paying stocks.

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Image source: Getty Images.

Turning into a butterfly?

For instance, Caterpillar has climbed more than any other Dow stock, with much of the stock's gains having come in just the past month. The maker of heavy equipment for applications including construction, energy, and mining suffered for years from sluggish macroeconomic conditions around the world, and things looked similarly downbeat coming into 2016. But throughout the year, many have expected these key areas of the global economy to bounce back. In particular, the results of the U.S. presidential election have spurred many to believe that greater government spending will stimulate the economy and bring big wins to Caterpillar. The company hasn't been quite as upbeat, suggesting recently that the level of optimism is overly ambitious compared to Caterpillar's near-term prospects. Nevertheless, in the long run, Caterpillar is setting itself up to take advantage of the next cyclical uptrend for its business. When that happens, the company's fundamentals should catch up with its share-price advance.

Feeling more energetic

For Chevron, the factors supporting higher prices have been even clearer. Coming into 2016, crude oil prices were extremely low, and early in the year, they fell into the $30s on a per-barrel basis. Since then, though, oil has not only bottomed out, it has bounced back, and its most recent push higher over the past week has sent it into a range between $50 and $55 per barrel. That's a far cry from the triple-digit figures that prevailed only a few short years ago, but Chevron has worked hard to make it through the tough period for the energy sector. Moreover, recent action from the OPEC cartel has many oil-industry followers believing that crude could hold onto its price gains. If that's the case, then repeated writedowns from falling oil prices could be at an end, and that will let Chevron report better earnings and encourage shareholders who've had to endure a tough period for the stock.

Big Blue stops singing the blues

Finally, IBM has finally started making some progress at recapturing its lost forward momentum. Big Blue long ago realized that it couldn't survive solely on its groundbreaking hardware business, because commodity producers had captured the market and slashed the profit margin figures that IBM had been able to sustain in the past. IBM instead turned to software and services as a place to look for better bottom-line growth. Even that had been a source of trouble for IBM, with the company seeing declines in software-related revenue for seven straight quarters over the past couple of years. But with software sales starting to tick back upward again, investors are growing more optimistic that Big Blue could finally start delivering the long-term returns that its innovative history has helped produce in the past.

The Dow's blue-chip giants are all impressive, but these top-paying dividend stocks could be even more valuable for your portfolio. Be sure to keep an eye on beaten-down Dow stocks, because sometimes, they'll be the ones that bounce back the furthest when conditions improve.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.