Highest-Yielding Stocks (You Might Actually Want to Buy)

This article is part of our Rising 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.

Siegel says...
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:

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:

Source: S&P Capital IQ.

Entergy, American Electric Power, and H&R Block are all new to the screen this month. W.P. Carey, Meredith, and Lockheed Martin dropped out of the top 10.

TAL International topped the list last month, and the leaser of intermodal freight containers raised its quarterly dividend by 6% to $0.55 per share. Alliance Resource Partners, meanwhile, hiked its payout 3.7% to $0.99 per unit.

Also, in seeking out companies with the potential to outperform over the long term, I'll often look at return-on-equity and return-on-assets numbers. Higher numbers indicate stronger competitive advantages, and on that measure Alliance Resource Partners and H&R Block score well, as do Eli Lilly and Avon. It's interesting to see two more utilities join the list, but like their peers, Entergy and American Electric Power share the high yields and growing dividends that make utilities attractive to so many investors.

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. For more dividend ideas, you may also be interested in our special free report, "13 High-Yielding Stocks to Buy Today."