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By Josh Peters, CFA | 05-18-2009 01:15 PM

Four Rally Wallflowers with Alluring Dividend Yields

These strong dividend-payers haven't rallied hard and are still trading at compelling valuations.

Josh Peters: Hello, this is Josh Peters, editor of Morningstar DividendInvestor. Up until the last couple of months, I actually found a lot to be encouraged about in the falling stock-market value overall. Dividend yields, which had been very low in the preceding 15 years, were starting to move to highs that we hadn't seen since the early 1990s, or even late 1980s. This was a pretty encouraging sign. Between World War II and about 1994, the average dividend yield of the S&P 500 ranged between three and six percent. A three-percent yield meant that investors were paying rather a lot for the dividend stream of the market overall, and perhaps equities were overpriced. A six-percent yield, as in August of 1982, suggested that perhaps stocks were undervalued, especially relative to the cash that they were paying out to their investors.

So, as the yield on the S&P 500 was hurdling towards the four-percent level earlier this year, I had to feel at least some long-term encouragement. Now, not so much. The yield on the S&P is probably back down to less than two-and-a-half percent right now. What we've had since March 9th, when the market bottomed, is a combination of stock prices rising, which drives dividend yields down in the good way, and continued dividend cutting, which drives yields down the bad way.

So this indicator, dividend yield, which was finally starting to show some promise for investors for the first time in a very long time, is starting to make the stock market look less attractive. But there is a nice way around this particular problem. That is that a lot of stocks that haven't reduced their dividends, whose dividends are not really at risk, and whose dividends continue to grow, are continuing to be available at pretty attractive prices. You might think of these as, really, the wallflowers of the market rally.

And easy names come to mind. Johnson and Johnson and Abbott Labs, for example, both companies that have raised their dividends this year, are likely to continue raising them at a good clip going forward, available at yields in the three-and-a-half to four-percent range. Not a whole lot of risk to a dividend cut there.

In some cases, utilities, which had been quite expensive on a relative basis, relative to history, over the last couple of years, can be had at six-percent yields, in some cases better. Southern Company, an excellent example of a high-quality utility that is available at a good price, and it just hasn't had the kind of rebound that other, more cyclical areas of the economy have.

Another name to mention: McCormick, an excellent manufacturer of packaged foods, specializing in spices. The stock hasn't really done much over the last couple of months, even as the rest of the market has come up over 30 percent. It's been a wallflower. People aren't interested in the companies that are the most stable, the companies that are continuing to grow. They're off chasing beneficiaries of an economic rebound.

What you can have with these wallflower stocks, especially the ones that pay good dividends, is your cake and eat it too. You can avoid having to bet on an economic recovery, especially that all-difficult question of when and how much the economy will recover, and stick with companies that are relatively conservative.

You can also dodge the dividend-yield problem. The market, overall, may still only yield two-and-a-half percent, still pretty poor by long-run historic standards. But you can buy stocks with yields of anywhere from three to six percent today, dividends that are really quite reliable, that can provide a good baseline for your total return expectations going forward, with continued growth and without a whole lot of risk.

You can bet, as editor of Morningstar DividendInvestor and manager of its two model portfolios, these wallflower, dividend-paying stocks are where I'm finding the best opportunities today.

So, with that, I'd like to thank you very much for watching. This has been Josh Peters, editor of Morningstar DividendInvestor.

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