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Stocks That Pay Big Dividends Still a Smart Bet


Despite the risk-on switch in the market so far this year, yield plays still have a place in the bull market and a fair bit of room to run.


Dividend-paying stocks are so 2011, right?

The big, stodgy companies that pay dividends to shareholders did well when the markets were sinking last year. Consumer-staples stocks, utilities, telecoms, what have you, all set the pace while investors avoided growth like the plague.

But since someone pushed the "risk-on" button last October, dividend-paying warhorses have lagged the market's fleet fillies - small-cap stocks and emerging markets. Even so, many dividend-paying stocks trade near their 52-week highs.

Yet there's still a strong case to be made for these stocks, although I would wait for a market pullback to buy them or add to what you have.

It comes down to yield in a low-return world: the possibility of increasing income, which is unlikely with bonds at this point, as well as relative protection in bear markets, and simply nowhere else to go for most people. And there's one more compelling reason to own these stocks, which I'll get to later.

But the most important reason, of course, is yield. Federal Reserve Chairman Ben S. Bernanke has pushed the federal funds rate down to near zero, and will keep it there for at least two more years.

So, savers are earning less than 1% from even the highest-paying money market funds. Other accounts pay even less. It's a joke.

As for bonds, Treasuries yield anywhere from 0.25% on the short end to less than 2% for 10-year notes, and barely 3% for 30-year bonds. And investors have poured nearly $800 billion into taxable bond funds since 2007, so they could suffer capital losses if bonds sell off, as many expect them to.

"There is a desperation on the part of a lot of investors who require cash flow and are not getting it off other investments," said Charles Carlson, chief executive officer of Horizon Investment Services and editor of DRIP Investor, an investment newsletter that focuses on dividend-paying stocks.

Meanwhile, the S&P 500 index yields just over 2%, and the Dow Jones Industrial Average yields 2.5%. Both yield more than the 10-year Treasury, only the second time that's happened since 1947. The last time was near the market bottom in 2008-2009.

And the really good news is that companies can always raise dividends…and some do consistently.

Corporations certainly have the wherewithal to boost payouts. Earnings of the S&P 500 have taken off by an amazing 125% since the end of 2009. And though their gains have slowed, analysts and strategists still expect earnings to grow in the mid-single digits.

As I'm sure you know, nonfinancial companies in the S&P 500 hold nearly $2 trillion in cash on their balance sheets; Apple (AAPL) alone has almost $100 billion in cash.

That huge cash hoard allows corporations to boost their dividend payouts and stock buybacks, which also help lift share prices. (There's even speculation about Apple instituting a stock dividend, but I'll believe it when I see it.)

Dividends paid by S&P 500 companies in 2011 totaled $240 billion, a 16% jump from 2010 and the highest level since 2008, according to DRIP Investor. And in the 12 months ended September 2011, "positive" dividend actions (instituting or raising a dividend) outnumbered "negative" actions (reducing or suspending dividends) by 328-to-6. (The ratio was a much narrower 1.4:1 in the 12 months ended September 2009, according to S&P.)

In fact, as Carlson points out, the current dividend payout ratio of 28% (the percentage of corporate profits paid out in dividends) is far lower than its 20-year average payout ratio of 40%. So there's plenty of room for growth there.

And these stocks also may offer higher returns than you'd expect.

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