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Investors appreciating dividends

Investors have come back around to the importance of dividends.

Dividends have always been a big component of overall stock returns, but they get more attention in today’s investment climate—in which stocks climb to new highs before crashing right back down, and intermediate-term bonds yield less than 2 percent.

When fixed-income investments yield so little, and stocks go on a roller-coaster ride, many investors are content to sit back with solid dividend-paying equities and happily accept their tax-advantaged (for now) 4 percent yields. Any capital gains are just a cherry on top.

So how can investors who want to go the dividend route build a solid portfolio?

Exchange-traded funds make it easy. Many companies offer ETFs packed full of high dividend-payers. For example, Vanguard’s High Dividend Yield ETF (ticker symbol: VYM) pays out about 3.2 percent annually. Its top holdings are Exxon Mobil, Microsoft, Chevron, General Electric and AT&T. The fund holds 438 stocks, giving investors a diversified portfolio with one holding.

More intrepid dividend investors can seek out stocks that yield more than ETFs such as Vanguard’s. One good source is a Web site based on Charles Carlson’s “The Little Book of Big Dividends: A Safe Formula for Guaranteed Returns.”

Carlson’s main argument is that dividend investors shouldn’t base their stock picks solely on yields. An extremely high yield could be a warning sign that the dividend is about to be slashed, which is also likely to crater the stock price.

Carlson uses yield as just one factor in picking dividend stocks. He places a high emphasis on payout ratios, which calculate how much of a company’s earnings are paid out in dividends. He recommends companies that pay out nice dividends that aren’t much more than half their earnings. If the payout ratio is higher than that it could again be a sign the dividend will be cut.

Carlson also looks at a company’s interest coverage, cash flow, dividend growth, earnings prospects and more. He mixes the factors together and assigns stocks a “BSD” score—Big Safe Dividend.

Investors can see the results on Carlson’s website, bigsafedivid (a login is required). The site also allows investors to rank stocks in the S&P 1500 by yields and other metrics.

A number of well-known companies yielding better than 4 percent with payout ratios of less than 50 percent turn up on Carlson’s site. Among them: ConocoPhillips, Lockheed Martin and Eli Lilly.

Staff reporter Bill Freehling writes this weekly column on business, personal finance and investing. He can be reached at 540/374-5405 or