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Develop a strategy for dividend-paying stocks

As bank stocks are rocked by subprime losses, their share prices are tumbling and their dividends are rising. With CD yields eroding, it can be tempting to look at rising stock dividends and jump on board, but in some cases that could be a bad move. Developing a strategy for investing in dividend-paying stocks is key.

Washington Mutual's stock price has plummeted from the mid-40's to the high teens. By contrast, its dividend has risen from around 4 percent to nearly 13 percent as of this writing. Has all of the bad news been shaken out of WaMu? Who knows? But some experts caution against going for the highest-yielding opportunities.

"You want to look at the underlying fundamentals," says Scott Schluederberg, portfolio manager at Hardesty Capital Management. "Are they going to have to set aside extremely high levels of loan loss reserves or something like that which will impact their ability to sustain that dividend? You have to look at the overall economic viability and future prospects near term and long term for the company."

Dividend-paying stocks can boost your portfolio's return significantly. In 2006, the total return for S&P 500 dividend payers was 14.73 percent versus 12.93 percent for nonpayers. According to Standard & Poor's, dividends have comprised just over 40 percent of the total return since 1926.

But as the number of companies that don't pay dividends grows, we may see changes in terms of the percentage of the total return that's attributed to dividends, says S&P index analyst Howard Silverblatt.

Financial companies' dividends
Company Dividend (%)

"The further back you go, more companies paid dividends; now most companies don't," he explains. "Currently, 77.6 percent of companies within the S&P 500 index pay dividends; but of the non-S&P 500 companies, only around 39 percent pay, down from 41 percent at the end of last year."

Effect on retirement income
Dividend-paying stocks tend to be a little less volatile than nonpayers. Schluederberg says his company incorporates them into every portfolio, in part because they can prop up the stock's share price during market pullbacks. As the stock's price drops a bit, the yield rises and starts looking attractive to investors.

"We have two strategies," says Schluederberg. "One is a core investment growth strategy, and within that we incorporate what we call trophy dividend growers. These are companies that pay increasingly higher dividends every year and have been able to sustain that for decades, stocks such as Procter & Gamble, Johnson & Johnson and 3M.

Next: "Keep in mind that a dividend strategy needs time to work."
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