10 income-paying stocks that beat the crowd

Reuters

SAN FRANCISCO (MarketWatch) � Stock investors no longer have doubts about dividends, and that�s reason for some doubt.

Shares of high-quality, cash-rich, large-cap companies that yield more than the Standard & Poor�s 500-stock index SPX are the new favorites in many portfolios. But many of these success stories have been discovered, boosting share prices and trimming yields.

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At this point, investors might do better scouring the S&P 500 for companies that wouldn�t show up on a screen for above-average yielders, but which still enjoy dominant, �wide moat� positions in their business.

�It�s kind of a crowded trade,� said Paul Nolte, managing director at investment firm Dearborn Partners, about the popularity of the high-quality dividend strategy. �Valuations on high-dividend payers are at the upper-end of their historical ranges.�

Indeed, money has cascaded into dividend-focused mutual funds and exchange-traded funds. Dow Jones Select Dividend Index Fund DVY , for example, saw assets grow to around $10 billion from $6 billion a year earlier, according to the ETF Industry Association. Similarly robust asset growth was seen at Vanguard Dividend Appreciation VIG �and SPDR S&P Dividend SDY .

It�s easy to see why dividends are in demand. They�re an alternative to bonds� paltry payouts, and cushion volatility. Plus, these stocks offer potential for capital appreciation.

Without dividends, the S&P 500 was flat in 2011; including dividends the market returned 2.1%. The yield-rich Dow Jones Industrial Average DJIA �fared even better, up 5.5%. And the 10 highest-yielding Dow components, the so-called Dogs of the Dow, returned 12.2%.

�Any time we see a big surge in the popularity of dividends in the market, that means prices have been marked up and it�s tough to find bargains,� said Josh Peters, editor of Morningstar�s DividendInvestor newsletter.

Off the beaten path

Owning financially healthy companies that reward shareholders with meaningful income is certainly still a viable investment idea. Large-cap stocks with little or no debt, that pay consistent dividends, and which grow those payouts over time, have been excellent decisions. And 3% or 4% in cash payments every year is nothing to ignore. Read more: How to elude the Fed's attack on savers.

Last year, for example, the average S&P 500 dividend payer gained 1.4%, compared to the average 7.6% decline for non-payers, according to S&P. Performance was even better for S&P�s �Dividend Aristocrats� � companies with that have boosted payouts for at least 25 consecutive years, such as AT&T Inc. T , Johnson & Johnson JNJ , McDonald�s Corp. MCD and Procter & Gamble Co. PG . Research S&P's Dividend Aristocrats.

Many investors now are hoping such dividend magic will apply to Apple Inc. AAPL , which earlier this week reported blowout earnings. Apple�s chief financial officer said the company is considering ways to be proactive with a cash hoard approaching $100 billion. Read more: Apple's growth rate will not last.

Apple isn�t paying a dividend, but if it did, the dividend world would spin. �If Apple came out with a policy that was going to give the stock a yield of 4%, you bet I would look at it,� said Morningstar�s Peters. Read more: Is Apple the cheapest growth stock?

But investing in a company that might pay a dividend isn�t a solid approach; nor is buying the highest yield. Companies in financial trouble often sport unusually fat yields after the shares have taken a beating, and their ability to maintain the dividend is questionable.

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Better to focus on dividend-paying companies in robust financial health, and then consider how that quarterly payment could grow. The dividend might not be terrific now, but a well-run operation with a high return on investment is often the kind of company given to dividend hikes. And dividend investing is a long-term strategy; the goal is to �clip coupons� year after year.

�Think in terms of what the yield could be, rather than what it is,� said Don Taylor, manager of Franklin Rising Dividends Fund FRDPX .