Highest-Yielding Stocks Unlikely to Blow Up

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.

Siegel says...
Most people now recognize the power of dividendinvesting. 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:

1. Market cap > $1 billion

2. Payout ratio < 60%

3. Three-year dividend growth > 0%

Here are the top 10 highest yielders the screen produced:

3- YearCumulative DividendGrowth

Dividend Yield

Pioneer Southwest Energy Partners (NYS: PSE) $1,00250%151%7.4%
Alliance Resource Partners (NAS: ARLP) $2,33544%41%6.3%
TAL International Group (NYS: TAL) $1,38759%24%5.6%
Exelon (NYS: EXC) $33,13758%8%5.4%
H&R Block$4,39256%4%5.4%
PPL (NYS: PPL) $15,82751%7%5.3%
American Electric Power$18,74346%13%4.9%
W.P. Carey & Co.$1,87855%10%4.8%
W&T Offshore$1,4848%33%4.8%

Source: S&P Capital IQ.

Pioneer Southwest jumps up to the top of the list this month. The oil and gas producer operates mainly in the Spraberry field in the Permian Basin area of West Texas. Like the next highest yielder on the screen, Alliance Resource Partners, Pioneer is a master limited partnership. This has its advantages and disadvantages, as laid out here by fellow Fool Dan Dzombak.

TAL International had been on top of my list for the past few months, but its price is up and thus its yield has dropped slightly -- from 6% to 5.6%. It's been one of the better performers since I started tracking this screen. Meanwhile, following up on some other energy companies from last month, Exelon continues to offer strong upside. The largest generator of nuclear power in the U.S. will benefit heavily as other forms of energy become more expensive. And PPL, which has lagged the S&P over the past year, is very reasonably valued at about 11 times this year's EPS estimates.

These 10 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 this article 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 written covered straddle 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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