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My 3 Favorite Income Stocks

07/12/2011 11:30 am EST


Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Dividend-paying stocks by and large easily handled the worst of the bear market, notes Mark Skousen of High-Income Alert, who shares three of his top picks with yields of 6% or more.

Most Wall Street analysts are still bearish because of the end of the Fed's quantitative easing (QE2).

But let us not forget that the Federal Reserve remains the biggest buyer of Treasuries, even now, as the central bank will buy as much as $300 billion of government debt in the next 12 months just from the proceeds of the maturing debt that it owns.

Meanwhile, the money supply (M2) is growing at 7%, the fastest rate all year long (up from 5%). That’s bullish in the short run, and perhaps the mini-stock market rally last week was the beginning of a trend.

Our biggest beneficiary of ZIRP (zero-interest-rate policy) is our income stocks and funds . Despite the bear market since May, two of our positions are outright profitable, and two others are close to our buy price.

History shows that dividend-paying stocks generally hold up much better than the broad market during down periods. Why? Only companies that are profitable and growing can afford to pay dividends.

But there's another reason dividend-paying stocks perform better. In a flat market, most non-dividend-paying stocks return nothing. But holdings with substantial dividend yields will provide a decent return, even if there is no share-price appreciation.

Where to Invest Now
A good conservative play with great upside potential is AT&T (T), America’s largest telephone company.

I’ve been recommending it all year long as one of the “Flying Five,” the five cheapest-priced, highest-yielding Dow stocks.

And it’s still a buy, even after advancing more than 20% in the past year. The stock is selling for only eight times earnings. And, earnings are up 39% on revenues of $125 billion.

AT&T profit margins are 16.7% and its return on equity (ROE) is 19%—far above its competitors, Verizon and Sprint.

Ma Bell features relatively low debt levels, stable cash flow, and high dividends. Its 5.7% yield is the highest of all Dow stocks—and the company can afford to pay more.

In addition, AT&T continues to expand, and is offering 4G speeds on its mobile broadband and U-verse TV applications. Indeed, AT&T is approaching 100 million customers.

AT&T is a buy. Set a protective stop at $25. For those willing to take greater risks, consider buying the October $32 calls.

I like the prospects for Telefonica (TEF), too. The European phone giant currently yields more than 9%.

Massive yields like this often are worthy of further investigation. But Telefonica’s payout ratio is a moderate 61%, and the company has grown earnings at a 19% annual rate over the last three years. I see further share-price appreciation here, plus dividend growth as well.

PennyMac Mortgage Investment Trust (PMT) is a stock with a double-digit dividend yield. PennyMac’s mission is to keep borrowers in their homes and provide investors with attractive returns. Yet it does not invest in a mortgage until it confirms a borrower’s willingness and ability to pay his or her mortgage.

PennyMac is good at what it does. Both revenue and net income are growing at triple-digit percentage rates. Operating margins top 68%. And the high yield here is, again, likely to be increased in the months ahead.

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