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Income investors should pick strong dividend growth over high current yield, says Richard Moroney of Dow Theory Forecasts.

Like mountain climbers, income investors fixated on yield are more likely to run into trouble at higher elevations.

Companies with fat yields and high payout ratios tend to have fewer resources to react when disaster strikes, threatening future dividend growth and share-price appreciation.

Rather than scaling the yield curve, investors should consider companies capable of generating strong dividend growth. The pool of such companies appears well stocked.

Currently, 82% of companies in the S&P 500 pay a dividend, the highest level since 1999, according to Standard & Poor’s.

Through June 21, 218 companies in the S&P 500 Index had announced dividend increases in 2013, up 9% from the first half of 2012. More than one-quarter of those hikes equaled or exceeded 20%. Growth numbers exclude special dividends.

Despite the aggressive dividend growth, we see plenty of room for more. The S&P 500 Index as a whole has a payout ratio (percentage of earnings paid out in dividends) of about 33%, well below the 25-year average of 39%.

Three recommended stocks with especially strong prospects for dividend growth are reviewed below.

A 20% dividend hike from Comcast (CMCSA) in February pushed the quarterly distribution to $0.195 per share, more than triple its initial payout in 2008.

The completion of the NBC Universal acquisition has freed up some cash flow. The company generated $7.20 billion in free cash flow in the 12 months ended March. Comcast also plans to repurchase $2 billion in shares this year.

In the mature US cable industry, Comcast has successfully pushed through higher rates, while nudging subscribers into its bundled products.

More than 40% of Comcast subscribers take its TV, Internet, and phone combo package. Management is also bullish on the network’s advertising prospects for the 2014 Winter Olympics.

The consensus projects earnings per share will climb at an 18% annual clip over the next five years.  Comcast, yielding 2.0%, is a Long-Term Buy.

EMC (EMC) took a friendlier stance toward shareholders in May, initiating a quarterly dividend of $0.10 per share and approving a $6 billion stock buyback through 2015.

EMC is part of the migration of technology stocks toward dividends. The firm entered the June quarter holding $6.53 billion in cash, the result of higher free cash flow in 13 of the past 16 quarters.

EMC has said it seeks to return more than half of its free cash flow to investors through stock buybacks and dividend payments; the current dividend represents no more than 25% of free cash flow. EMC, yielding 1.7%, is a long-term buy.

Wells Fargo (WFC), one of the healthiest US banks to emerge from the financial crisis, has raised its quarterly dividend five times since the beginning of 2011.

The bank’s annualized dividend growth over the last three years stands at 81%, versus its sector median of 18% growth.

And its 2.9% yield exceeds the 2.4% median for S&P 500 financial stocks.  With an overall rank of 95 and both sector-specific scores above 90, Wells Fargo is a long-term buy.

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Tickers Mentioned: CMCSA, EMC, WFC

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