Seeking the Holy Grail of Yield

The quest for sustainable long-term returns seems to be legendarily treacherous these days, but MoneyShow's Howard R. Gold, also of The Independent Agenda, has gathered a few suggestions from top income experts.

Investors love yield and hate risk. Why else would they still be dumping equities and chasing overvalued fixed-income investments like Treasuries, TIPS and high-yield bonds?

But the one bright spot is dividend-paying stocks: As of late August, $13.6 billion of investors' cash has flowed into dividend-stock and equity-income mutual funds this year.

Higher yields than Treasuries and the prospect of share-price appreciation make dividend-paying stocks look like the Holy Grail of investing. Yet certain sectors, such as consumer staples, already are in "nosebleed territory," Barron's recently reported.

And a couple of weeks ago, bond maven Marilyn Cohen called dividend-paying stocks "the most crowded trade ever."

• Read Howard's take on the three most overvalued assets.

Still, there must be something that pays out more than bonds without the ups and downs of, say, Facebook (FB) or Zynga (ZNGA).

Last week, I moderated a panel at the MoneyShow Chicago whose theme was income investing. A couple of the panelists I talked to later thought there were still opportunities in dividend investing-if you're selective.

 "There's still a...difference between what you can get in bonds and what you can get from dividend-paying stocks," said Roger Conrad, editor of Utility Forecaster.

And Mark Skousen, editor-in-chief of Forecasts & Strategies and the author or more than 25 books on economics and markets, was even more bullish. "We're in the sweet spot for income investing-it doesn't get better than this," he declared, pointing out that "alternative investments-savings accounts, T-bills, long-term Treasuries [have] just awful returns."

"People who are in those are scared," he continued. "They don't want to lose their principal."

But if they looked a little harder and took a bit more risk-as Federal Reserve chairman Ben Bernanke wants us to-they might make more money and paradoxically be less exposed than they are in many bonds and bond funds.

Unlike bonds, said Conrad, "dividend-paying stocks follow the overall stock market. Historically there's not much of a link to bond yields."

So when interest rates start rising again, bonds could be hit harder than dividend-paying stocks. But which ones should people look at?

• Read Howard's take on what the latest polls show the about the impact of the first debate on the election.

The iShares High Dividend Equity (HDV) and Vanguard Dividend Yield (VYM) ETFs have both beaten the S&P 500 during the past two years, though they have lagged recently. Both yield around 2.9%.

Skousen thinks you can find better yields by doing a little digging.

NEXT: Good Picks for Dividend Investors

He's particularly fond of business development companies, publicly traded companies that invest in businesses the way private-equity firms do. "They are investing in these private companies, funding them, charging them very nice fees," he said.

Main Street Capital (MAIN), based in Houston, invests primarily in small and midsized companies in the South and Southwest involved in traditional businesses. Like other private-equity firms, MAIN's holding period is generally three to seven years. At around $29.50, just shy of its all-time high near $31, the stock changes hands at 15 times next year's estimated earnings of $1.97 a share.

MAIN pays an annual dividend of $1.80 in monthly installments, for a yield of around 5.9%. Unfortunately, the price has soared by more than 60% over the past 12 months, so you might want to wait for a pullback to buy.

Skousen also likes Vanguard Natural Resources (VNR)-no relation to the fund company. Also based in Houston, Vanguard owns and develops oil and natural gas reserves in the western US. At a closing price Wednesday above $29, it's close to its all-time high, though it sells at less than twice book value.

And it yields a hefty 8.2% on a $2.40 per share annual dividend payment. "You normally don't see yields like this with oil and gas firms," said Skousen. Dividend payments have risen 41% since 2007.

If you can deal with those awful K1 tax forms-and the risk of plunging oil and gas prices-it might be worth checking out.

Roger Conrad is a fan of good old-fashioned utilities. The Dow Jones Utility Average, he pointed out, has rallied in the fourth quarter 36 times out of the last 42 years, before taking a breather in the first few weeks of the new year.

Conrad, whose Utility Forecaster is rated a top performer by the Hulbert Financial Digest, likes NV Energy (NVE). NVE is a utility based in depressed Nevada, which, he said, has "a very clear flight plan for their growth. They don't have to go ask [regulators] for higher rates." Ten years ago, NVE imported 80% of its energy; now it's producing 80%.

NVE yields 3.7% and has doubled its quarterly dividend since August 2008. "They've been increasing the dividend at a pretty rapid rate and are planning to continue that. It's not a high-risk proposition," said Conrad.

As I said, dividend-paying stocks have had a good run, and you may want to wait for a deeper pullback before buying. They shouldn't be the only equities you own. And you might consider mixing individual selections with diversified ETFs like HDV and VYM.

But the case for dividend-paying stocks remains as compelling as when I wrote about them earlier this year.

• Read Howard's earlier analysis of why dividend-paying stocks were a good bet.

"There is a real demand for yield, and stocks are the only game in town," said Conrad-that is, if investors can get past their fear.