With the uncertainty hanging over stocks in the past few months, the media has been touting the power of dividends. My favorite is a recent article in USA Today, where analysts and researchers make obligatory comments about why companies with robust dividend payments make sense in a bumpy market.

The argument for dividends
Don't get me wrong: It's great to hear the media calling out our beloved dividend payers as investment ideas, but the tone of these articles is decidedly short term. The USA Today piece, for example, cites S&P data showing that through July of this year, dividend payers were up 4.3%, while non-dividend payers were down 3.3%. That's a significant difference, but unfortunately, that short time period says nothing about what the future holds.

Dividend-payer Brinker International (NYSE:EAT) is up 23% this year, including dividends, but that doesn't mean it's always going to outperform a non-dividend payer such as Urban Outfitters (NASDAQ:URBN), which is down 29% from where it started the year. Investing just isn't that simple, and the recent run-up in the past few months confirms just how short-term such thinking can be.

Narrowing the field
Selecting the right dividend payers requires an understanding of the balance between the current valuation, the current yield, and the likelihood of increases in dividend payments. When recommending companies for our Motley FoolIncome Investor service, lead analyst James Early focuses on companies that have more than enough free cash flow (FCF) to cover their dividends, as well as strong prospects for growing FCF and dividends in the future. Income Investor selection GlaxoSmithKline (NYSE:GSK) is a perfect example of this, and the four companies below are attractive as well.

Company

Yield

FCF Payout Ratio

UST (NYSE:UST)

4.3%

69.9%

General Mills (NYSE:GIS)

2.5%

36.4%

Cadbury Schweppes (NYSE:CSG)

2.5%

41.3%

British Sky Broadcasting (NYSE:BSY)

2.4%

27.1%


The real deal
The recent attention being showered on dividend-paying companies isn't entirely misplaced: Dividends do offer protection and support in a falling market. But dividend investing also offers much more. Many dividend payers can also outperform in a bull market, and with growing payouts, they provide cash for continual reinvestment. That's a tough combination to beat.

To learn more about dividend-paying stocks and buying high-quality companies at reasonable prices, take a free 30-day trial to Income Investor. Focusing on dividend-paying companies such as Glaxo has the service beating the market by more than six percentage points overall. Click here to learn more.

This article was originally published on Aug. 4, 2006. It has been updated.

At the time of publication, Nathan Parmelee had no financial stake in any of the companies mentioned. The Fool is investors writing for investors.