Will the Democrats take the fun out of investing in high-yield stocks? There’s little chance they will try to hike taxes on dividends before 2010, but at that time, when the reduced 15% level is set to expire, the issue may become a political football, a lobbyist with the Federalist Group in Washington, Gordon Taylor, says.

Until then, high-yield advocates such as the portfolio manager with Schafer Cullen Capital Management, John Gould, intend to take advantage of the low income tax rates, as well as unusually good prospects for dividend growth in coming years.

Mr. Gould wants add a little security to your securities. Along with James Cullen, he manages the Cullen High Dividend Value Equity Fund. The fund invests in high-yield, large cap stocks and recently celebrated its third birthday with a four-star rating from Morningstar.

Mr. Gould makes a compelling case for high yield stocks. First, he points out that since 1927 dividends have accounted for almost 46% of the returns generated by common stocks. While there have been periods when dividends were not so important to returns, such as the high-growth 1950s and the super-bubble 1990s, more often than not high-yield stocks have accounted for better than 40% of total returns.

More compelling is that high-yield stocks have substantially outperformed low-yield issues. Looking at cumulative returns between 1957 and 2005, he claims that stocks in the top quintile on the basis of yield vastly outdid the bottom quintile. Specifically, the numbers show that $1,000 invested in the top 20% rose in value to $584,860 over that period, compared with $69,283 for the bottom 20%. Certainly, an impressive difference.

This is not just a historical phenomenon. In 2004, the top 100 stocks in terms of yield outperformed the S &P by nearly 500 basis points, and since 2000 the top-yielding issues have earned 12% annually on average, compared with a less than 1% return for the broader average.

Mr. Gould not only looks for stocks with high yields, but also seeks issues that have low valuations and some catalyst for dividend growth. So as to avoid loading up on sectors traditionally paying high dividends, he has set limits on his holdings of REITs (capped at 12% of the total fund) and utilities (8%).

One fertile source of high-yield prospects is overseas markets. The portion of the portfolio invested in foreign stocks, many of which are well-known names such as Unilever and BP, has increased over time. While in the 1990s international securities accounted for about 10% of the total portfolio, today the figure is closer to 25%.

He emphasizes long-term objectives, and consequently the fund has relatively low turnover, about 25% a year. Today, it is exactly this long-term perspective that draws him to the high-yield sector. Mr. Gould points out that the dividend yield today on the S &P 500 is 1.79%. By comparison, since 1960 the yield has averaged 3.25%.

Also, the payout ratio, or the amount of earnings being paid out as dividends, is around 21%, also unusually low. By comparison, for the past five years the payout has been 32%, and the average over time has been 54%.

This drop in payout coincides with a remarkable build-up in cash on companies’ balance sheets. Over the past 25 years, cash has accounted for approximately 16% of total market capitalization; today, the number is better than 20%. Although companies have engaged in sizeable stock buy-backs, the increases in dividends have been slow, according to Standard & Poor’s.

Repurchases for S&P 500 stocks picked up momentum in the final quarter of 2004, when the total topped $100 billion for the first time, and have stayed above that figure since. Total dividends paid in the most recent quarter amounted to $54.8 billion, compared to buybacks of $109.8 billion.

With corporations awash in cash, why the miserly payouts? For one thing, as earnings skyrocket, dividend increases usually lag, so payouts go down. Corporations are reluctant to raise dividend rates too rapidly for fear that the earnings growth will slow, and that gains will prove ephemeral. It is not healthy for management to lower the stated dividend rate, to put it mildly. So, though an increasing number of corporations have announced dividend hikes this year, the increases have not kept pace with earnings growth.

This strikes Mr. Gould as an opportune time to build positions in companies likely to hike dividends going forward. However, he follows rigorous guidelines as to valuation. Consequently, stocks in his portfolio are currently selling at about 14 times earnings, or somewhat below the S&P 500, despite an expected above-average growth rate of 9.4%, compared with 8%.

So how has Schafer Cullen done using their disciplines? Long-term results are only available for the firm’s managed portfolios, since the mutual fund is fairly new. The accounts have done quite well, outperforming the S&P 500 over the past 10-, five-, three-, and oneyear time frames. They have outperformed the Russell 1000.

The mutual fund also has outperformed its category, according to Morningstar, both for the past three years and the most recent 12 months. Mr. Gould is not too concerned about possible changes in tax policy. “We think the strategy is sound going forward regardless of tax changes,” he says. It would seem so.

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