How to win the quest for yield with stocks

Reuters

CHICAGO (MarketWatch) � A plot reminiscent of �The Hunger Games� is playing out for income-seeking investors.

In the quest for yield, both dividend-paying stocks and corporate bonds (including lower-rated high-yield issues) have both rewarded investors. Now, like the �kill or be killed� girl and boy leads in the uber-popular film, corporate bonds and dividend stocks are going their separate ways.

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What�s stirring the crowd? Dividends.

�Yield is a scarce and thus, a coveted asset,� said Michael Hartnett, Bank of America Merrill Lynch�s chief global equity strategist.

Many companies are now paying dividends well in excess of their own bond yields. The yield spread of U.S. BAA-rated corporate bonds over the Standard & Poor�s 500 Index dividend yield is near its lowest level in almost 45 years, according to Merrill.

Some 390 dividend-paying companies were counted among the S&P 500 SPX � as 2011 wrapped up. That marked a 12-year high, according to FactSet Research.

�Dividend yield had the best performance in 2011 and continues to do well in 2012,� Merrill equity strategists said in a recent research note. �Investor fund flows over the past few years have been concentrated on yield in bond markets. But with corporate bond yields now at multi-decade lows, the popularity of equity income funds has started to accelerate.�

Merrill strategists remain bullish on �convertible yield.� That�s their description of the ongoing rotation from fixed-income yield into equity-derived income.

They consider the typically riskier equity patch (at least versus bonds) as not only the more desirable income generator right now, but as a source of growth without necessarily sacrificing quality.

�Assets that produce the best growth, the highest quality and the highest yield will continue to outperform in this low growth, low rates �Era of Deleveraging,� Meriill analysts noted in a March research report.

For example, several Dow Jones Industrial Average DJIA �companies that recently sported dividend yields in excess of their comparable five-year bond yield include AT&T Inc. T , Verizon Communications Inc. VZ , Merck�& Co. MRK , Johnson & Johnson JNJ , Procter & Gamble Co.PG �and Intel Corp. INTC �

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In addition, when dividend yields exceed bond yields, companies have greater incentive to buy back stock and to issue new debt, Merrill analysts said, adding that owning companies which have repurchased shares has been a top investment strategy over the past few years.

Dividend strength won�t be exclusive to the U.S. At 3.7%, European dividend yields are just shy of their 90-year average of 3.9%, Hartnett said. Dividends may outperform global bonds, a category ravaged by the debt crisis but potentially attractive to risk-takers. Hartnett and company don�t think the reward is enough: the dividend yield for the MSCI All Country World Index is now 2.7% while global government bond yields are just 1.5%.