3 more stocks for beating the bear

By Jim Jubak

High dividends are supposed to make a stock safe in a falling market.

Well, in 2008 it hasn't exactly worked out that way. Eight of the nine stocks in my Dividend Stocks for Income Investors portfolio show losses for 2008 that range from a piddling 1.93% to a huge 52.17%. And that's including even the dividends.

That isn't simply bad stock picking on my part. The damage is by no means limited to my income portfolio. The Dow Jones Utility Average ($UTIL) dropped to 444.21 on Sept. 9. Utility stocks hadn't been lower than that since Oct. 19, 2006.

That is why I think this is the perfect time to add three stocks to the "unfixed-income" portfolio I launched April 11 with a buy of US Bancorp (USB, news, msgs). I added three more stocks to that list June 27: Enbridge (ENB, news, msgs), ING (ING, news, msgs) and Toronto Dominion (TD, news, msgs).

A fine fix

For those of you coming in late, let me start by summarizing the strategy behind my unfixed-income portfolio. Then I'll move on to telling you why high dividends have provided so little protection this year and the logic behind buying high-dividend stocks now.

The strategy, which I'm calling unfixed-income investing, is designed to help you keep up with inflation -- and more -- while growing the yields of your income investments over time.

This strategy starts with common stocks that pay high dividends. My goal is to find equity investments with yields above the percentage paid by five-year Treasury notes (2.94% on Sept. 12) or, even better, above the yield on 10-year Treasury notes (3.71% on Sept 12). And these common stocks should be as safe as or safer than the five- or 10-year Treasurys under current market conditions.

Then I add a third criterion: These common stocks should have superior histories of raising dividends year in and year out. It's this last element that gives income investors a fighting chance to beat today's low yields and stay ahead of inflation. How does it work? By putting the power of dividend compounding to work for long-term income investors.

Let me use US Bancorp, my first unfixed-income pick, as an example of how this works. The yield on US Bancorp -- 5.05% on Sept. 12 -- is certainly high enough to make the cut. And this conservatively run bank is certainly safe enough.

But it is US Bancorp's commitment to returning 80% of earnings to shareholders that made it the first stock in my unfixed-income portfolio. Combine that commitment with the bank's steady rate of earnings growth -- 8.5% annually over the past five years -- and what you get is a stock with constantly increasing dividends for shareholders. In 2003, the stock paid 86 cents a share in dividends. The dividend payment has climbed steadily to $1.70 a share in 2008, an increase of 98%.

Look at what the power of dividend compounding can do for US Bancorp's dividend yield in the long run. If US Bancorp can grow dividends per share by just 10% this year and next -- that would be below the average annual 16% increase of the past five years -- by April 2010, an investor would be looking at a dividend of $2.06 a share. That would represent a 6.1% yield for an investor who bought at the Sept. 12 closing price.

The current yield of 5.05% is great now, when the 10-year Treasury note yields 3.7%. And the 6.1% future yield will look even better if future U.S. interest rates are lower because of slower growth or a huge demand for fixed-income investments from aging boomers.

Think of buying a stock like this now as purchasing an option on increasing future dividends and higher yields.

On sale now

You won't find stocks like this with dividends like this at prices this low once the bear market is over and growth in the U.S. economy picks up. It's precisely because the present is so scary to so many investors that such bargains show the current yields they do: Enbridge at 3.3%, ING at 7.3% and Toronto Dominion at 3.9%, for example.

I understand why buying a dividend stock can be so scary at a time like this. Heck, buying any stock at a time like this takes a huge leap of faith. But income stocks are especially scary right now because they're supposed to be safe, and they haven't been. Macquarie Infrastructure (MIC, news, msgs), for example, which I own in my Dividend Stocks for Income Investors portfolio, is down 52.17% for 2008.

That's not safe by any definition I know.

Continued: Why they haven't been safe

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