For many investors, the only reward that matters is an increase in share price. The faster and steeper that ascent, the better. Movements in price are the most obvious and talked-about way to earn profits from the stock market. Every night, the news broadcast flashes the price and percentage change for the Dow, S&P 500, or Nasdaq -- not the price-to-earnings ratio (P/E) or yield for each index.

Look beyond those capital gains, however, and you might find a dividend. For long-term investors, dividends are far from one-time gains -- they can be the special sauce that provides market-shattering performance. For instance, a dividend can be a regular cash addition to your portfolio. It allows you to pick up more shares of common stock. Sometimes, it allows you to take advantage of opportune moments when the shares are on sale. But perhaps most important is that the dividend grows over time, just like sales and earnings.

Dividends in action
For evidence of the power of dividends, take a look at the payouts a company has made over the years. Put together a spreadsheet that begins with the core position (and cost basis), and calculate how reinvesting dividends would have purchased additional shares over time (generally each quarter). Although it takes a little bit of time, the power of dividends becomes quite clear. (To get started, all you need to do is find historical price data, which is available on sites such as Yahoo! Finance.) I've done such an exercise before (found here) for Wrigley (NYSE: WWY).

A few companies make this easier for us by providing a return calculator in the investor relations portion of their websites. Johnson & Johnson's (NYSE: JNJ) website, for example, has data that goes back to July 1980.

To research the historical performance of Johnson & Johnson, I punched in 100 fictional shares with a purchase date of July 28, 1980 (the first date allowed). The purchase price on that day was $80.13 for a total initial cost of $8,012.50. I'm well aware that $8,000 is not a small amount for many investors, but because Johnson & Johnson does not charge an initial setup fee or any fees for dividend reinvestment, the percentages work out the same regardless of the initial amount.

According to J&J's calculator, as of today (at a price of $60.97) those same 100 shares, with no additional contributions and dividends reinvested, are now approximately 3,327 shares and are worth more than $202,850. That's a total return of 2,431%, or approximately 13.3% per year. Remember that initial $8,012.50 investment? Each year, you'd now receive more in dividends than your initial cost basis. J&J does not provide a comparison to the S&P 500, but a quick glance Yahoo! Finance shows that over the same time period the S&P 500 returned 944% (9.8% annualized).

Dividend stock performance, July 28, 1980, to Dec. 22, 2005

It takes time to get going
The time frame of this exercise reveals the most difficult thing about dividend investing -- it takes time. Dividends are cumulative and grow over time, so it can take several years before the true benefits take hold. And during periods of stock price decline or flatness it can feel like you're treading water.

However, dividends do eventually take hold. In The Future for Investors, Jeremy Siegel espouses a long-term dividend reinvestment strategy based on research that showed how soundly dividend-paying stocks outperformed non-dividend payers from 1957 to 2003. Since 1957, Johnson & Johnson isn't one of the S&P's top 20 performers. In fact, its 13.3% return from 1980 to 2005 is still less than the 13.58% return the 20th-ranked company on the list, General Mills, earned from 1957 to 2003. Many familiar names did rank well: PepsiCo (NYSE: PEP), Fortune Brands (NYSE: FO), and Procter & Gamble (NYSE: PG) came in at 8th, 13th, and 16th, respectively.

Many investors believe that because dividends are taxed at a higher rate than capital gains their effects are not as strong as advertised. This belief has some truth to it, but it is possible to maximize the benefits of dividends while laying out plans to minimize taxes and transaction costs. For investors with IRAs, investing in dividend-paying stocks makes a great deal of sense, because the dividends and the returns they earn while reinvested will not be taxed until withdrawn, and even then they'll be taxed at the long-term capital gains rate.

With a little patience, the power of dividends can be put to work in your account. Consider this very interesting email I received last month from a reader, which closed with the following paragraph:

Finally, I'm employed by a transfer agent. It's amazing how much cash some wealthy/long-term investors are receiving via their periodical dividend checks and/or reinvestment purchases. It is mind-blowing in some cases. If I hadn't seen all this with my very own eyes, I wouldn't believe it. It's certainly something to aspire to.

Despite the fact that we've received a great deal of positive feedback from folks who like the name of our dividend-oriented newsletter, Motley Fool Income Investor, it seems that some readers are slightly confused by the title. This is evidenced by comments I occasionally receive such as "I enjoy your writing, but I'm too young to focus on dividends" or "I like the idea of dividend-paying stocks, but I don't need the income offered by your newsletter."

So, let's clarify a few things about the focus of this service and the purpose of a dividend-oriented investment strategy. Though I've said it before, I can't say it enough: Dividend investing is not age-specific, nor do most people who invest in dividend stocks require the income. Just to be clear, income is simply an additional benefit of the dividend strategy, not its sole purpose.

Investing against the grain
Many perceive dividend-paying stocks as boring investments with low growth potential or that they're meant exclusively for investors approaching retirement. While there's every reason that your father or grandfather should own these stocks, too, nothing could be further from the truth.

Numerous detailed studies have determined that, over the long term, the stocks of companies that pay dividends tend to outperform the stocks of those that don't. They also tend to outperform the S&P 500. Even better, they do this while generating far less volatility than their stingy competitors, which means there's a greater chance that your money will be there when you need it.

So, while income is certainly a benefit, a dividend strategy is -- at its core -- nothing more than an excellent screening tool for producing a pool of low-risk companies with market-beating potential.

That's why I usually refer to this method of investing as "the ability to have your cake and eat it if you want to." If you happen to be watching your figure at the moment and choosing to save your cake for later, that's fine, too -- and easily accomplished through dividend reinvestment or holding your dividend payers in tax-advantaged accounts. Certainly, even among dividend stocks, one must still choose her investments wisely (that is, Foolishly), but this criterion can be a very good place to start.

The forgotten art
According to the Financial Analysts Journal, dividend-payout ratios have been in the bottom 10% of the historical range since 1995. As you might suspect, they reached unprecedented lows during the height of the market bubble -- from late 1999 to mid-2001 -- before recovering somewhat over the past few years.

Many think that it's better for companies to retain all of their earnings because they assume that the company can reinvest them more profitably than they can. However, if that were true, non-dividend-paying companies would outperform dividend payers. But again, the data does not support this. Indeed, it appears that a given company's decision to pay a dividend -- or increase it -- is, historically, a much more reliable indicator of management's confidence in future earnings than the decision to retain profits.

Though there are many firms out there with excellent management, I think we've seen enough to know that putting too much faith in a manager's benevolence is unwise. Even in the case of many quality managers, their interests are not always aligned with those of shareholders, and this can lead to destruction of capital.

To forgo dividends entirely is to effectively take a leap of faith that management will always act in shareholders' best interests and not engage in undesirable practices, such as compensating itself excessively or engaging in empire building via dilutive acquisitions.

Given the recent resurgence in the popularity of dividend-paying stocks -- which has likely resulted from reduced faith in management to honestly and effectively deploy capital, favorable tax cuts, and the poor performance of many non-dividend payers -- I believe the dividend is once again becoming an important component of the individual investor's decision-making process. This -- coupled with the likelihood of below-average overall stock market returns in the years to come -- bodes well for a dividend-focused strategy because it means that dividends will play a larger role in total returns.

The results
The average dividend yield of my Income Investor recommendations is 4.55%, or three times that of the S&P 500. These picks have also experienced just half the volatility of the overall market.

But, of course, you have to sacrifice growth to get those kinds of results, right? Not so fast. Despite our stodgy dividend focus, our service has managed to generate a total return nearly two times greater than that of the S&P 500. Further, 21 of our 30 recommendations have produced double-digit returns, with 12 of those generating a total return of more than 20% and six of them returning more than 30%. Consistency is another benefit of our approach, with 26 of our 30 selections outperforming the S&P.

Believe me, friends, when I say that the dividend is back, and we don't have to sacrifice a thing to hail its return. Our general target company will have a dividend yield approaching 3%, which is a fairly high benchmark to achieve in today's market, but this target tends to lead us to better values that also have better growth potential. Another beauty of the strategy is that you'll get paid to wait for the market to realize those values. If the price remains low, you'll simply have an opportunity to reinvest your dividends at that low price or you may choose to cash in on your 3% as needed.

While this target would currently exclude a fantastic company such as PepsiCo (NYSE: PEP) -- with its current yield of 1.8% -- from becoming a core recommendation, it also keeps us from paying too much for proven winners. Indeed, I never lose faith that the PepsiCos or Wal-Marts (NYSE: WMT) of the world will one day find their way into the pages of Income Investor, as firms fall into the market's "forgotten list" for one reason or another. And that's when the real dividend values come out to play. After all, if we can snatch up shares of such proven companies as RPM International (NYSE: RPM) and Sara Lee (NYSE: SLE) -- which have generated total returns for our subscribers of 33.7% and 21.9%, respectively -- when they're yielding nearly 4%, then the PepsiCos and the Johnson & Johnsons (NYSE: JNJ) are certainly in the realm of possibility.

The Foolish bottom line
I'm not trying to make dividend investing cool here. In fact, I'd prefer that it remain decidedly uncool, as this creates more chances for us dividend lovers to find market-beating companies that also pay out the cabbage.

I'm also not suggesting that every company in your arsenal pay a dividend -- there are many fine companies that don't. (However, I would say that as these companies continue their track records of success, it's likely that many of them will become dividend payers in their own right.)

Frankly, what some call maturity, I call stability -- as exemplified by the recent news of a dividend increase and one-time payout at Microsoft (Nasdaq: MSFT) -- and I believe plenty of investors will find dividend investing both stable and rewarding.

Fool on!

This article was originally published on September 13, 2004. It has been updated.

As author of the Fool's dividend-oriented newsletter, Motley Fool Income Investor, one of the most common emails that I receive goes something like this:

Dear Mr. Emmert,

In order to meet my income needs, I need some investment ideas that will produce a yield in the 10%-12% range. What would you suggest?

Sincerely,

Over the holiday weekend, my wife and I went back to my hometown to visit with friends and family. It's always nice to catch up on old times, but my work here at the Fool inevitably comes up at these little gatherings. As an investing nut, I'm constantly encouraging everyone within earshot to save and invest.

I've been riding one particular friend -- a new father -- to start putting some money to work for his daughter. You see, I missed the opportunity to start investing earlier in life, and I don't want others to pass up the power of reinvesting dividends over time.

My friend understands that he needs to save and invest for his daughter, Bella, but he is wary of stocks because of his past experience as an employee at Lucent Technology (NYSE: LU). In fairness, working at Lucent wasn't so bad, but the investing experience in his 401(k) wasn't any fun. He stashed the majority of his assets into shares of Lucent. As an employee in the late 1990s and for part of 2000, it doesn't take a mathematician to figure out that his largest investment experience to date wasn't very rewarding.

Despite this negative experience, my friend also realizes that some of the problem was his own doing, and he's coming around to the idea that some businesses are more predictable than others -- and that some definitely carry more risk than others. Like me, he also likes the idea of getting part of his return now in dividends.

The power of sugar and branding
Luckily, my friend and I share something in common: a love of sugar. For years I've been subjecting my teeth to sugary beverages from Coca-Cola (NYSE: KO) and PepsiCo (NYSE: PEP), as well as candy and gum from companies such as Hershey Foods (NYSE: HSY). Given the long-term track records of food, candy, and beverage companies and their ability to raise prices over time, it's tough to think of a better place to start. The other reason to love these companies is that they tend to pay dividends that can be reinvested, and many companies even increase their payouts every year.

To prove the power of investing in general, and the importance of adding dividends to the mix, I chose two companies that are often cited as strong performers and have rewarded their shareholders with dividends year after year. In addition, I also wanted to do the math quarter by quarter to prove the benefits of this strategy to myself.

I chose July 1, 1988, as my starting point. That's the approximate day I began earning a regular paycheck and, theoretically, could have begun investing on my own. I was only in junior high at the time and my income was meager, but it was steady. I started with $250 for each investment, and for the sake of mathematical simplicity I specified that no further cash was added but that all dividends were reinvested. If you have children with larger earning power, you can always start with a higher base and use the numbers below to arrive at a far larger total return in dollar terms.

Whatever it is I think I see
The first stock for my mock exercise is Tootsie Roll Industries (NYSE: TR). We've all been munching on Tootsie Rolls for years, and the company has historically done quite well for shareholders. For my experiment, however, Tootsie wasn't the winner (though it did not do poorly). After starting with a little more than eight shares from the $250 investment, and factoring in reinvested dividends and splits, I'd have over 52 shares worth approximately $1,650 today. That's about a 560% return vs. an S&P 500 return of 345% for the same time period.

Considering that Tootsie pays an annual 3% stock dividend (via a 103-to-100 split ratio) and a little more than 1% in cash each year, that's not bad. Unfortunately, Tootsie Roll's business has been a bit stagnant the past few years, as have the dividends and share price. That said, the company still has a solid balance sheet and generates a strong amount of free cash flow. Considering the long-term performance of the company and the fact that candy doesn't go out of style, investors should keep Tootsie Roll on their radar.

Make a fortune in bubble gum
The other company I looked at is Wrigley (NYSE: WWY). Just like Tootsie Roll, Wrigley has generated absolutely fabulous historical returns for shareholders. In this historical exercise, the original six shares of Wrigley purchased in 1988 ballooned into just over 56 shares and a value of $3,850 today. That's a market-smashing 1,440% return. And while the current 1.6% dividend yield is small, it is a bit deceiving because I'd be receiving approximately $91 a year in dividends on my original $250 investment. Such a comparison of dividends paid to original investment is not a wise way to value a stock, but it does an excellent job of highlighting the effects of dividend growth over time.

It's also worth noting that Wrigley's stock has been a very steady historical performer -- because the business has been a very steady performer. There have, however, been occasional swoons during which time shares fell by 20% or more. Those short-term blips are the opportunities we need to seize with companies like Wrigley.

Foolish final words
The above exercise was fun, easy to understand, and -- at least for me -- enlightening. As my friend became comfortable with such investments, I would strongly urge him to adopt a Motley Fool Income Investor strategy. I think the 3%-plus dividend yield from an Income Investor selection like Diageo (NYSE: DEO) is easy to understand and would boost the overall return on investment.

For now, though, I'll settle for just getting him to start investing for his daughter's future. Whether the money goes toward college or backpacking around Europe, the power of reinvesting dividends over time is something that no one should miss out on.

Over the years, I've been asked the same question: How do I build a flexible portfolio that will continue to meet my long-term needs? Since I write the Fool's dividend-stock newsletter, Motley Fool Income Investor, it won't surprise many of you to hear me say that I believe a dividend-oriented portfolio achieves the best of all worlds, for all people. But after a recent visit with a large group of investors, I believe it's more important than ever to say so.

Though a dividend-oriented strategy would seem like an easy sell to many of you, that's not necessarily the case with the average investor, young or old. About a month ago, I had the pleasure of speaking at the National Association of Investors Corporation's convention in Atlanta, and this fact was driven home by some of the questions posed to me there.

It seems that many older investors have overlooked the dividend-oriented investment strategy altogether. Instead, they've gone with the oft-preached tack of buying "growth" stocks throughout their younger years and adding an ever-larger portion of bonds as they approach retirement. Interestingly, the concept of relying solely on income from a stock portfolio is foreign to many of them.

I think this is largely because dividend yields have appeared too low to convince folks that they would receive adequate income when they need it. Of course, what they've failed to consider is that the best companies, such as Bank of America (NYSE: BAC) and AGL Resources (NYSE: ATG), tend to increase their dividends at rates well above the rate of inflation. Thus, the yield on their original investment would prove much more meaningful over time.

Get flexible at no cost to you!
Certainly, there are many things to like about a dividend portfolio. That your stocks fall just half as much as non-payers during bear markets is an obvious one. Then there's the fact that, despite the lower volatility and business risk, your long-term returns tend to be higher than those of the market as a whole (by at least a couple of percentage points over nearly any period).

But at its core, a dividend strategy is about ultimate flexibility. As I've said, it lets you have your cake and eat it if you want to. In other words, if you need the income, you take it. If you don't, you reinvest it until you need it. And by then, you'll likely have the means to produce a larger income than you could have imagined.

For the older folks who are looking for income, there's more flexibility with a dividend portfolio today than at any other time in history. Consider that most brokerage firms and Drip plans now give you the choice between reinvesting dividends or receiving cash payments at the individual company level -- sometimes even at an individual share level.

For example, say you have a portfolio with 20 dividend-paying stocks. Most firms now let you reinvest dividends on your entire portfolio. Otherwise, you can pick a few companies for reinvestment and get the dividends on the remainder of the portfolio as cash. Indeed, some account providers will let you go a step further and specify the number of shares of a given holding on which you'd like to reinvest or receive the dividends. Thus, you have considerable control over exactly how much income you'd like to receive as cash at any one time. Turning the spigot on or off doesn't come so easily with any other strategy.

The whippersnapper
Then we have the younger folks (for our purposes, that could mean anyone from ages 20 to 60). The reaction of these people to the title Income Investor is easily predicted: "But I don't need income."

My response, of course, is that it doesn't matter. If you don't need income from your dividend portfolio today, you simply reinvest it. "But won't I have to pay taxes on the dividends when they're paid?" they ask. Yes (unless you're holding it in a tax-free account), but it still doesn't matter.

As I mentioned last month, beyond singling out good companies up front, choosing to reinvest dividends is the most important investment decision you'll ever make. According to data compiled by author Jeremy Siegel, reinvesting dividends in quality companies beats all other investing strategies hands down.

Indeed, if you'd begun investing in 1897 and reinvested your dividends along the way, 97% of your account's value today would be the result of reinvested dividends. This means capital appreciation accounted for 3% of the total. Which would you rather have: the 3% received by the so-called growth investor or the 97% the dividend investor got?

This best illustrates my goal for the Income Investor newsletter service. I'm not merely looking for good stock picks here. I also want to provide you with a low-risk, high-return, lifelong solution to portfolio management.

The bottom line is that investors need to realize that a dividend-oriented strategy offers something for everyone: the ability to beat the market while maintaining flexibility. If you're young, reinvest your dividends and beat the returns of all other investors. If you're a little older, build the most flexible and diverse income stream possible. And in either case, sit back and enjoy your results.

Fool on!