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Dan Dorfman

Dan Dorfman

Posted: July 26, 2010 12:45 PM

A Bigger Bang For Your Buck

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For many, if not most Americans, it's as crucial as Medicare and a good drug plan.

That's the need for low-risk, higher interest income -- a flow of funds that will help you live out your golden years with dignity. But finding a fatter, low-risk return is getting to be as rare as ferreting out that proverbial needle in the haystack in this deplorably low, near zero interest-rate environment.

Want to do something about it? Then read on because what follows is another worthwhile ingredient for financial survival -- namely, how to snare a bigger bang for your income-producing buck and put more money in your pocket.

At the moment, that seems far more relevant than salivating about your next sexual conquest, gaping at your favorite TV show, griping about the Administration's woeful inability to resolve our economic woes or day-dreaming about a date with Brad Pitt or Angelina Jolie.

HuffPost doesn't provide financial advice and neither do I, but I thought a request from one distressed reader, a widow who recently lost her job as a librarian and e-mailed me, deserves a thoughtful response. "I need more interest income and I have some money I can invest," she wrote. "I am especially interested in dividend-paying stocks. What are your best ideas?"

For starters, watch out. While there are fatter returns inherent in certain dividend-paying stocks, they're still stocks, and even those were unable to walk away unscathed during the savage market declines in recent years. In other words, you're still flirting with risk.

With that in mind, here's how veteran investment adviser Stephen Leeb, skipper of the Leeb's Income Performance Letter, a monthly New York newsletter, thinks people fed up with painfully paltry interest might want to try to capitalize on dividend power in the equity market through quality blue chips.

There are, of course, as we all know, safer alternatives, such as bank CDs, money-market funds and short-term Treasury securities, but their returns are for the birds (mostly under 1%). And if you factor in inflation and taxes, you come out a loser.

Other vehicles, such as high-quality corporate bonds, Treasury bonds, convertibles, preferred shares and bond funds, can also fill the bill for additional low-risk income, but since our reader's preference is dividend-paying stocks, let's focus on those, keeping in mind, the higher the yield, usually the greater the risk.

Clearly, if you want to put money to work in dividend-paying stocks, it behooves you to make certain the company has the financial muscle to ensure a continuity of the dividend, as well as increase it, in bad times, as well as in good times.

In this context, Leeb points out that 30 years ago some 60 U.S. companies held the highest AAA credit rating. Today, there are only four, each of which sports a higher dividend yield than the average 1.9% payout of the S&P 500. They are Automatic Data Processing (yield: 3.25%), Johnson & Johnson (3.75%), Microsoft (2.1%), and Exxon (3.1%).

Leeb favors the shares of all four as a group investment
for a number of reasons.

--They should turn in a reliable performance in 2010's challenging economy and tougher investment climate.

--They'll all survive no matter what, primarily because of strong barriers to entry by would-be rivals.

--They'll continue to grow because of their dominant industry positions.

--They all have the capability to raise payouts well ahead of inflation in the years ahead.

--All four are attractively priced in light of their future growth potential and financial strength.

Leeb also points out that the four companies collectively should provide a pleasing combination of low-risk growth and reliable, rising income, and "you'll earn a good total return that will let you sleep at night."

From a capital appreciation standpoint, one money management source at Baltimore-based investment biggie T. Rowe Price tells me he thinks each of the four stocks, given a decent market, has the potential to throw off a 15% to 25% gain over the next 12 months.

Elaborating on the letter's dividend thinking, one of its editors, Gregory Dorsey, notes that six companies are among a select group that have raised their income streams every year for the past 25 years. They are Becton Dickinson (2.1% yield), Family Dollar Stores (1.5%), PepsiCo (3%), Emerson Electric (2.8%) and two companies mentioned earlier, Automatic Data Processing and Johnson & Johnson.

Dorsey figures all six are in fine shape to repeat that feat this year, with the biggest dividend gains likely to come from J&J, Family Dollar and PepsiCo based on their expected earnings growth and low payout as a percentage of earnings.

Some other dividend-paying favorites of our T. Rowe Price source are Philip Morris (4.5%), IBM (2%), Lockheed Martin (3.4%), Chevron (4%) and ConocoPhillips (4%).

Meanwhile, a study by another newsletter, Dow Theory Forecasts, shows that $1,000 invested in high-yield stocks at the start of 1927 would have grown to $4.7 million by the end of 2009, more than eight times the value of a portfolio of a portfolio of non-payers.

So there you have it, more bang for your buck, but not, you should keep in mind, without risk.

What do you think? E-mail me at Dandordan@aol.com