(Corrects column originally published Oct. 26 to delete inaccurate corporate history in 18th paragraph.)

Oct. 26 (Bloomberg) -- Dividends are as old-fashioned as corsets, if you listen to most investors.

How wrong they are.

From 1926 through 2006, dividends (and capital gains achieved by reinvesting dividends) accounted for about 40 percent of the total return on the Standard & Poor’s 500 Index. On the Dow Jones Industrial Average the figure is even higher, about 44 percent.

Ancient history? Hardly. In the 10 years through Sept. 30 the Dow fell more than 6 percent. Yet with dividends, investors gained almost 18 percent. That still works out to a puny 1.6 percent annual return, but it’s the difference between winning and losing.

Some of my clients have very specific uses for their dividends. One, for example, uses dividend income to pay for the care for an ill relative. Dividends also serve another purpose: they are a barometer of management’s optimism or pessimism.

When a company’s directors raise the dividend, chances are high that they believe earnings for the next few years will be sufficient to cover the increase. It’s embarrassing to raise a dividend, only to chop it within a year or two.

When I go hunting for stocks with dividend appeal, I look for two things. One is a substantial yield. In the current market, 2.3 percent is the average yield for the S&P 500. So I would classify 4 percent or higher as attractive.

Positive Outlook

I also look for growth in the dividend over the past five years, which indicates that a company’s prospects are improving, and perhaps that the improvement is sustainable.

For this column I screened about 2,100 U.S. stocks looking for ones with a dividend yield of least 5 percent, and with a five-year dividend growth rate of 5 percent or higher. I found almost four dozen stocks that qualified. Here are ones that I think have investment merit:

AT&T Inc., the biggest U.S. telephone company by market value, yields 6.4 percent in dividends, and its dividends have been growing at a 5.6 percent clip.

The yield seems reasonably secure. Dallas-based AT&T paid out 74 percent of its profits in dividends last year. I don’t usually start to worry much until the so-called payout ratio hits 80 percent.

I like the stock’s valuation statistics, too. It sells for 11 times earnings, 1.5 times book value (corporate net worth) and 1.2 times sales. Those are comforting ratios for a value investor.

Watch 2010 Earnings

The big question is growth. Land-line service has been declining while mobile-phone service has been rising. The former hurts AT&T, which is in both businesses; the latter helps. Competition is stiff. As a result, AT&T’s per share earnings growth has been uneven in recent years. This year, analysts think earnings will drop 26 percent from the 2008 level of $2.81 a share.

On the whole, I favor the stock, but I would watch earnings in 2010 to see if they rebound from the $2.09 or so expected this year.

Another high-dividend stock I like is Duke Energy Corp., based in Charlotte, North Carolina. Its power mix leans heavily toward nuclear energy, of which I am a proponent. The dividend yield is a solid 6 percent.

High Payout Rate

The sustainability of Duke’s dividend, though, is less certain than AT&T’s in my judgment. Duke is paying out 89 percent of its earnings in dividends currently. That doesn’t leave much room for error.

On the plus side, everything should be fine if Duke can get its earnings back up to normal. It earned $1.21 a share in 2008, and is expected to earn $1.20 in 2009. It has done considerably better in the past. Five times in the past 10 years, Duke’s earnings topped $1.50 a share.

Another utility stock I like is Westar Energy Inc., based in Topeka, Kansas. I owned this one for many of my clients in 2007 and 2008. Now that the market is improving, I have sold it to make room for more aggressive stocks.

Nonetheless, I still think Westar is appropriate for income-oriented portfolios. The stock yields 6.1 percent and sells for just under book value.

In a far different industry, and on a more speculative basis, I am intrigued by World Wrestling Entertainment Inc. The company, based in Stamford, Connecticut, promotes live and televised wrestling matches. Or shall we call them exhibitions?

Stage Fight

In fact, these events are meticulously choreographed pieces of sweaty theater with pre-ordained endings. And many people consider them immensely entertaining. The audience members --not all of whom are 13-year-old boys like my son -- seem fascinated by the personae of the various wrestlers, as well as the spectacle.

With a payout ratio of 179 percent, the dividend will likely be cut soon. However, the yield right now is more than 10 percent.

Penn Virginia Resource Partners LP is a coal miner and natural-gas processor with headquarters in Radnor, Pennsylvania. It has increased its quarterly dividend from 35 cents a quarter in early 2006 to 48 cents a quarter now.

The dividend may be in jeopardy, based on a recent payout ratio of 86 percent. I believe an improving economy will bail out the company. As earnings bounce back from recent depressed levels, I think the company will be spared the shame of a dividend cut.

The stock sells for 12 times earnings and the yield is a fat 9.8 percent.

Disclosure note: I do not currently own any of the stocks discussed in this column, either for myself or for clients.

(John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)

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To contact the writer of this column: John Dorfman at jdorfman@thunderstormcapital.com.

Last Updated: October 27, 2009 12:29 EDT