This article is part of ourRising Star Portfolios series.
My real-money Rising Star Portfolio uses a smart screening process to find great stocks. Today, we're going hunting for the most attractive high-yielding companies out there -- those with businesses strong enough to hopefully avoid a devastating dividend cut.
Most people now recognize the power of dividend investing. Higher-yielding stocks tend to offer higher returns over time than low- or no-yield stocks, according to research from Jeremy Siegel and others. In fact, the 20 best-performing survivor stocks from the original S&P 500 in 1957 are all dividend payers.
What's more, reinvesting dividends acts as a "bear-market protector and return accelerator," according to Siegel. The extra shares purchased and accumulated at higher dividend yields during down periods help protect portfolios in falling markets, and when these extra shares rise in value in good times, they accelerate returns.
As the recent economic crisis illustrated all too well, however, you can't buy just any high-yielding stock. Dividends that get cut or suspended entirely can wreak havoc on a stock price -- and thus your portfolio.
Reducing the risk
Fortunately, you can take several steps to lessen your chances of buying one of these train wrecks. James Early, advisor of our Motley Fool Income Investor service, suggests looking at the payout ratio for starters. That's simply the percentage of a company's net income used to pay its dividend. Obviously, the higher the payout ratio, the tougher it is for a company to meet its dividend obligation. James looks for a payout ratio below 80% for safer companies and a sub-60% or even 50% payout for companies you consider risky.
To further stack the odds on your side, you can limit your search to companies that have grown their dividend over the past three years or so. That eliminates the less stable or erratic dividend payers.
I constructed a screen to find some promising high-yield, low-risk U.S. companies for further research. I made sure the stocks met the following criteria:
Market cap > $1 billion
Payout ratio < 60%
Three-year dividend growth > 0%
Here are the top 10 highest yielders the screen produced:
3-Year Cumulative Dividend Growth
AT&T (NYS: T)
Sunoco Logistics Partners
Federated Investors (NYS: FII)
Lockheed Martin (NYS: LMT)
Alliance Resource Partners (NAS: ARLP)
Eli Lilly (NYS: LLY)
Bank of Hawaii (NYS: BOH)
Exelon (NYS: EXC)
Source: Capital IQ, a division of Standard & Poor's.
Another company to consider is The Buckle, which has a dividend yield of 2.1%. That seems low compared to the companies listed above, but the retailer is paying a special $2.25 dividend on Oct. 27, which pushes its effective yield to 8.1%. This will be the fourth straight year management has doled out a special dividend, but there's no guarantee it will continue to do so in the future.
These companies are now official candidates for my Rising Star Portfolio. To follow any of these companies, simply add them to your very own free, personalized watchlist. You may also be interested in our research report "13 High-Yielding Stocks to Buy Today." Click here to claim your free copy.
This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks.Click hereto see all of our Rising Star analysts (and their portfolios).
At the time thisarticle was published Fool analystRex Mooreis sanitized for your protection, but hisTwitter feedisn't. He owns no companies mentioned here. The Motley Fool owns shares of Bank of Hawaii and Lockheed Martin.Motley Fool newsletter serviceshave recommended buying shares of Alliance Resource Partners, AT&T, Exelon, and Federated Investors, as well as writing a covered strangle position on Exelon. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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