Pay me now: dividend-paving stocks can help protect your porfolio if the market takes a turn.

THE OCCASIONAL ROAD BUMP IS TO BE EXPECTED, AND that's exactly what investors have been getting lately. While the market continues to edge upward, overall it's been a pattern of setting new records, followed by periodic retreats. Take what happened in early July: Jitters over the rising rate of foreclosures, coupled with a few surprise earnings warnings, prompted a one-day drop of 148 points in the Dow. Then over the next two days the market shot up 360 points.

So what's an investor to do? In turbulent times, many investors like to bank on the reliability of dividend-paying stocks. The term isn't bandied about much anymore, but these so-called "widow-and-orphan stocks," were customarily well-established companies that posed little risk and paid a regular dividend. With people living longer and planning for retirements that could last for decades, more investors are taking an interest in generating a reliable income stream from their stock portfolios.

"Anything that pays dividends is putting more money into my pocket. It just makes sense," says Sharon Lay. Lay says she adds a minimum of $100 a month to her brokerage account with ShareBuilder.com. "However, one has to think long-term--these are stable growth companies, they are not going to be ricocheting up and down daily."

For starters, consider that dividend payments--a distribution of corporate earnings to shareholders--are a sign of corporate stability. After all, a company has to have a certain measure of financial health before management would choose to pay out profits rather than reinvest in the business. Also, management wants to avoid ever having to lower the dividend, which could be interpreted as a signal that there are problems. An added plus: Historically dividend-paying stocks have outperformed non-dividend paying stocks according to Ned Davis Research.

"As a single woman, I'm able to heavily invest in my portfolio; however, I want at least some guaranteed income," says Lay, who is a product manager for Motorola in Arlington Heights, Illinois. For the last seven years she's taken full advantage of Motorola's employee stock purchase program that allows employees to buy stock at a 15% discount. Though shares are currently well off their high, they carry a dividend yield--the amount of the annual dividend divided by the current stock price--of 1.1%. Some of the holdings in Lay's portfolio include AT&T (T), which offers a 3.6% yield; amusement park company Cedar Fair (FUN), which doles out 6.6%; and golf equipment maker Callaway Golf (ELY), which sports a dividend of 1.6%. By comparison, the average dividend yield of the S&P 500 is 1.6%.

"On a historic basis, dividend-paying stocks have turned out to be the real key to building wealth," says William Young, president and chief operating officer of Buford, Dickson, Harper & Sparrow, a St. Louis-based institutional money manager. But putting their track record aside, another driver of the increased interest in dividends was a 2003 change in the tax laws that reduced the maximum federal tax rate on qualified dividends to 15% for most investors. At the moment, a sunset provision means that this law will expire in 2010.

F. Douglass Lewis Jr., president of FDL Financial Services Inc. in Washington D.C., recommends investors take a look at Cedar Fair (FUN), a Sandusky, Ohio-based operator of amusement and water parks. "The parks have been very profitable, so it's only a matter of taking the new parks and implementing the successful template," says Lewis, whose firm manages $35 million in equity. He's looking for Cedar Fair to grow revenues from $831 million in 2006 to more than $1 billion this year. Trading at $29 and sporting a dividend yield of 6.6%, Lewis is looking for shares to climb by 20%, to $35, in the next 12 to 18 months.

Calvin Baker, senior portfolio manager for Baltimore's Brown Capital Management (No. 5 on the BE ASSET MANAGERS list with $2.7 billion in assets under management), also likes the stock He notes that Cedar Fair is structured as a limited partnership, so the principals are interested in the income. In July, the company announced that revenues through the first six months of this year were up 2%, or $3.3 million--reflecting an increase in spending by park visitors, though attendance had dropped slightly.

Investors who enjoy an occasional cocktail may want to consider indulging in Diageo pie (DEO), the world's largest producer of premium alcoholic drinks. The London-based company owns many of the leading brands including Guinness stout, Johnnie Walker Scotch whiskies, Jose Cuervo tequila, and Smirnoff vodka, among others. Trading around $84 in early July, shares offered a dividend of 2.3%, and Baker expects shares to climb to $95. "Given their dominant position in these key brands and the international markets that they are continuing to focus on," he says, "they will continue to be the premier dominant company in that drinks/liquor market."

As a contrarian play, Pfizer (PFE), the New York City-based pharmaceutical titan, caught the eye of several money managers. Demographics are a solid reason why Young says the pharmaceutical industry is a good place to park some of your money. "We are in an aging environment where the majority of our population is rapidly living past 50 years old," he says, "and just like anything you have owned for 50 years, maintenance starts."

It's a contrarian play because Pfizer shares have seen better days. Looming patent expirations, perhaps most notably that of its blockbuster cholesterol drug, Lipitor, in 2010, have weighed heavily on the stock. It's a critical issue because Lipitor generated nearly $13 billion in sales last year--slightly more than 25% of Pfizer's total sales. Trading in the $25 range, Young expects shares to climb to $35 in the year ahead.

"[Shares aren't] going through the roof now, however it's a good, conservative stock with steady growth and a nice dividend yield of 4.6%," adds Lewis. "It's a stock that you buy, hold, and forget about; you have to be patient." Indeed there may be some benefit to that approach--for the last 40 years Pfizer investors have been rewarded with annual dividend increases.

PHOTOGRAPH BY HAYLEY MURPHY 

EDITED BY TREVOR DELANEY: [e-mail]

WHERE TO FIND
DIVIDENDS
A sector breakdown of the S&P 500

                          Total No.     Dividend
Sector                   of Companies    Payers

Consumer Discretionary        88           69
Consumer Staples              39           37
Energy                        32           28
Financials                    92           89
Healthcare                    54           27
Industrials                   53           50
Materials                     28           26
Information Technology        73           24
Telecom                        9            8
Utilities                     32           29
Total                        500          387

SOURCE: STANDARD & POOR'S

BEST BETS

                             Dividend       Market
Company (Ticker)    Price     Yield          Cap.

Cedar Fair (FUN)    $29.80     6.6%       $1.6 billion
Diageo (DEO)        $84.25     2.3%      $56.9 billion
Pfizer (PFE)        $25.88     4.6%     $115.5 billion

DATA AS OF 7/9/07

SOURCE: YAHOO' FINANCE