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 on our monthly hunt for the most attractive high-yielding companies out there -- those with businesses strong enough to hopefully avoid a devastating dividend cut.
What's more, this screen -- like all my others -- is now being tracked and scored on its very own CAPS page, so we can begin to accumulate valuable data and see how it performs. Mark it as a favorite so you can follow along.
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 sub-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:
TAL International Group (NYS: TAL)
Alliance Resource Partners (NAS: ARLP)
Exelon (NYS: EXC)
PPL (NYS: PPL)
American Electric Power
Eli Lilly (NYS: LLY)
Public Service Enterprise Group
Source: S&P Capital IQ.
TAL International tops the list for the third straight month. It recently raised its dividend by 6% to $0.55 per share, and while its payout ratio has crept up from 52% to 55%, it's still well under our 60% cap.
Four energy companies follow TAL in the battle for the highest yield. Alliance Resource Partners is a coal-producing master limited partnership that is benefiting from increasing demand for its product. Its price had quite a run-up from 2010 to halfway through 2011. It has since come down to earth some, meaning its valuation is a bit more reasonable. Exelon has underperformed the market over the past couple of years, and I think it offers more upside with a bit less risk than Alliance. PPL, meanwhile, announced a dividend increase in its quarterly dividend in February, to $0.36 per share. That's only a penny increase, but something my screen really likes to see.
Eli Lilly places high on the list with a 5% yield. As my colleague Dan Caplinger points out, the company trades rather cheaply because of the uncertainty surrounding some of its biggest products. Whether the shares are a true bargain depends on how well it can replace some of its drugs going off patent.
These companies are now official candidates for my Rising Star Portfolio. To follow any of these stocks, simply add them to your very own free, personalized watchlist. For more dividend ideas, you may also be interested in our special free report, "Secure Your Future With 9 Rock-Solid Dividend Stocks."
At the time thisarticle was published Fool analyst Rex Moore tweets but is not a twerp. He runs a real-money Rising Star portfolio based on his screens. He owns no companies mentioned here. Motley Fool newsletter services have recommended buying shares of Exelon and Alliance Resource Partners. Motley Fool newsletter services have recommended creating a write covered strangle position in Exelon. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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