FIRMS WITH 6+% DIVIDEND YIELDS

	Paul Tracy Street Authority.com
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The greatest investors of all time don't attempt to double their money overnight. In fact, even investing greats like Warren Buffett and Peter Lynch never managed to produce much better than a +30% annual gain for their investors in any given year. And most years, their returns were much smaller than that.

So, how did these investing legends beat the market over time?

They did so by capturing steady, consistent gains, year in and year out. Investing for the long haul is really nothing more than a game of compounding -- that is, earning a consistent return and reinvesting your profits in the market over time. In time, through the magic of compounding, even a small stake can grow into a tidy sum.

But for years, investors forgot one of the two pillars of any long-term compounding strategy -- dividends. In the late 1990s no one wanted to hear about dividends when the major averages were returning +15% or more annually in capital gains alone. In fact, no one seemed to notice or care when the S&P 500s dividend yield sank to an all-time low in March of 2000 of just 1.1%.

But the late 1990s were a highly unusual period in stock market history. Over the long run, dividends have made up as much as half of total stock market profits in any given year.

And if you think that a 3% or 4% dividend yield is trivial, think again, and check out my chart. This chart depicts two indices over the past 20 years -- the S&P 500 and the S&P 500 Total Return Index. The S&P 500 Total Return index is calculated by collecting all the dividends paid by companies in the S&P 500 and reinvesting them quarterly right back into the index. In short, the total return index attempts to mimic what the average investor would do when reinvesting dividends into the stock market.

Note what's happened over time. It's clear that the S&P 500 Total Return Index has vastly outperformed the S&P. Let's assume you started investing in 1986 with $10,000 and added $5,000 cash to your investment fund every year. Had you invested that money into the S&P 500, your investment would now be worth a little less than $2.5 million -- not a bad return. However, by simply reinvesting your quarterly dividends, your return would be closer to $3.2 million -- almost a million dollars more.

And dividends make an even bigger difference during bear markets or when the S&P 500 just trades sideways; the period from 1965 to 1980 is a classic example. From December 31, 1965 through December 31, 1979 the S&P 500 rose a grand total of +16.8%. On an annualized basis that's just +1.1% per year. That's not enough to even keep pace with inflation.

But with dividends reinvested, the S&P 500 returned about 5 times that much, more than +5% annualized. Over that same 14-year period, the S&P 500 returned over +100% if you reinvested your dividends. In other words, dividends turned a disastrous period into a reasonable return. With the market now trading sideways, dividends could be the key to capturing a decent return in the stock market in the coming years.

And while the S&P 500 has historically paid a higher dividend yield than it does today, it's certainly not an index of high dividend-paying stocks. The effect of this compounding would be even more dramatic if you examined more income-oriented stocks that yield even higher rates than the S&P 500 at large.

So why, you might ask, should an investor bother buying high-income stocks just to earn a few extra percentage points of return when the bond market offers a safer yield? Well, the answer is deceptively simple -- stock returns are really the product of two elements: dividends and capital gains.

Although income stocks do offer nice yields, they also offer decent growth prospects over time. Over the years, most income stocks -- and most stocks in general -- have risen. That means investors are earning not only stellar dividend yields, but also a capital gain on their investment. Bonds simply don't offer the same sort of appreciation potential over the long haul.

With these points in mind, my staff and I recently scoured the market in search of quality stocks with abnormally high dividend yields. But, there was more to this search than simply finding stocks with nice yields -- we took a myriad of fundamental qualities into consideration as well. Things we generally look for when buying income stocks include:

-- A long track record of paying dividends.
-- Growth in dividends over time.
-- Stable earnings profile.
-- Low payout ratios (companies paying out a huge percentage of their profits in dividends may have to cut those payouts in the future).
-- Larger companies generally offer more stable payouts.
-- Qualified dividends (some of the dividends paid by partnerships, REITs and preferreds aren't subject to the recently-reduced 15% tax rate).
-- Low long-term debt.
-- Non-cyclical businesses.

In the table that follows, I present a long list of promising companies with solid yields. Each of these companies offers at least a 6% dividend yield and has a market capitalization of more than $1 billion. And in the text that follows, I review two of my favorite high-yielding picks.

LLOYD'S TSB GROUP (LYG, $34.87)

Business Overview
Lloyd's is one of the largest financial institutions in the United Kingdom. In addition to offering mortgage and insurance services, the company operates a chain of retail banks around the U.K. The bank also operates an international banking and insurance business.

Competitive Advantages

In the banking industry, relationships are key. Banking is a highly competitive business; almost any financial institution can offer a mortgage, provide insurance or take a deposit from a customer.

The key is, of course, locking in customers and then cross-selling those customers on other products. In other words, a bank's customer list is key -- basic deposit or mortgage customers can be sold mortgages, insurance or other special services.

Lloyd's has 15 million customers in the U.K. and 2,200 branches. The company is also the third-largest mortgage lender in the nation and has one of the most respected brand names in the U.K. banking business, giving the firm a lasting competitive advantage in acquiring new customers.

Growth Drivers

I see two main areas of growth for LYG. First, the company has been shedding many of its money-losing foreign operations. Given that these businesses were a drag on profits, their removal should boost earnings considerably.

Secondly, the company's efforts to increase cross-selling are an avenue of growth. At one time the bank did a bad job of leveraging its existing customer base; even today customers spend more money buying products from the competition than from Lloyd's.

However, Lloyd's has now taken some positive steps to better cross-sell to its existing customers. These steps include adopting a sales commission structure for employees and expanding its Internet and telephone presence. In addition, Lloyd's is hiring retail "relationship managers" in an effort to sell more products to existing customers.

Valuation, Dividends and Outlook

Lloyd's trades at about 11 times earnings and should deliver long-term growth of between 4% and 7%. But with a dividend yield of 7.4%, the prime consideration here isn't growth, but instead is the sustainability of that yield. Thanks to its solid reputation and annual pre-tax profits of more than 3.5 billion pounds sterling ($6 billion), the firm's above-average dividend yield looks fairly safe.

Going forward, Lloyd's new CEO, Eric Daniels, has been progressive in turning around a once-sleepy bank. Daniels has firmly put the focus on enhancing profitability and making better use of existing customers.

And there's a kicker: Lloyd's could be a takeover target for any bank looking to gain a foothold in the European market. Citigroup has been earmarked as one potential acquirer.

UNITED UTILITIES (UU, $22.82)

Business Overview
United Utilities' main business is providing water and wastewater services to around 2.9 million customers in the Northwest part of England. In addition to water services, United offers electricity services to a smaller base in the same region. These regulated businesses make up about 90% of the company's profits.

That said, the company also has a presence in a promising growth market -- business process outsourcing. Basically, this unregulated business involves helping other utility companies manage their operations and/or customer service functions.

Competitive Advantages

The largest chunk of United's profits come from regulated businesses. Basically, the British government allows the company a set rate of return from its operations. This return is then adjusted by an efficiency measure. The more efficient United is in reducing costs, the higher its return on basic operations.

In this situation, United Utilities has two basic advantages. First, the regulated structure gives the company a monopoly over a certain part of the country -- in this case, that's northwest England.

Secondly, United has proven it's among the more efficient utilities. The company has been able to consistently reduce costs and, therefore, earn a higher return from its basic operations. Recently, the company garnered favorable rulings on both water and electric rates.

Growth Drivers

While the company's utility operations are the cash cow, the growth prospects from United's non-regulated businesses are solid. The firm's non-regulated business can be divided into two main units: Contract Solutions and Vertex.

The company's contract solutions unit helps manage infrastructure for other utilities. In fact, the company has a market-leading share in managing the assets of other British water utility companies. Because the company has a great record at keeping costs low, this is a logical business for United.

Vertex handles back and front office customer services operations. The company does this through offices both in the U.K. and India. In fact, the firm recently made a near 100 million pound acquisition to expand into the financial services field.

Although they are still in their infancy, the firm's unregulated operations offer some solid growth potential in the coming years.

Valuation, Dividends and Outlook

The company trades at only 11X estimated 2005 earnings and is projected to grow at approximately +10% annualized over the long term. As such, the stock appears to be reasonably valued.

The company's payout ratio has been running as high as 90%. Nevertheless, this isn't necessarily a bad thing in an industry with very predictable cash flows such as the utility space. Right now, the company is paying a yield of over 12%.

I sincerely hope you've enjoyed today's look at several companies with 6+% dividend yields. Please stay tuned for my next full issue, which I'll publish on Monday, August 1st. In it, my staff and I will take a closer look at the international investing landscape. With the U.S. markets now at fresh four-year highs, investors might be wise to diversify into a number of fast-growing foreign markets. Good investing in the week ahead!

Paul Tracy will be available to take your questions until Monday, August 25. Please use the form below to submit your questions.