Roger S. Conrad's  Instablog

Bonds have been in a seller's market since late 2009 and with rare exceptions, they're a poor place to put your money now. If you're investing for income, dividend-paying stocks are your only real choice.

The ability to issue 30-year bonds at little more than 4 percent interest is extremely bullish for companies' growth, but it leaves bond buyers with meager returns.

Meanwhile, bond yields have rarely been this low for long. A rise to more normal levels, say 5 percent to 6 percent, would take a huge bite out of principal. Losses would be catastrophic for many bond funds, because they commonly employ massive leverage to pay higher yields than the bonds they hold.

Dividend-paying stocks aren't the bargains they were in early 2009, or even last autumn. However, strong companies from a wide range of industries still yield 5 percent to 7 percent-and they're consistently growing those payouts every year, sometimes every quarter.

Consistently growing dividends are a sign of financial strength, of a real business making real profits. Dividend-paying stocks' prices will follow a rising payout higher over time, increasing capital gains.

There's no one perfect sector or stock. Every choice carries dividend risk and is vulnerable to overvaluation as well. The key to successful dividend investing is to diversify and maintain a rough balance among different companies and sectors. That way no one stock can sink your portfolio if its shares stumble in these times of uneven economic growth and uncertain global credit markets.

Dividend-paying stocks will only maximize yield, dividend growth and capital gains if you buy and hold. As I told readers in my Investing Daily article, Dividend-Paying Stocks and Riding Rough Seas that means living with both inflation and credit risk.

Conventional wisdom is that dividend-paying stocks always sell off when interest rates rise. The opposite has been true, since the end of 2007.

The yield on 10-year US Treasury notes-the benchmark rate for all income investments-has plunged sharply three times since 2007, as safety-seeking investors fled to the only global market large enough to accommodate them.

The first was during the crash of 2008; the second in 2010 in the wake of worries about European credit; and the third in 2011, during the market panic following S&P's downgrade of US government debt. However, each time Treasury bonds soared-and rates fell-dividend-paying stocks crashed across the board. Conversely, when the panic subsided and Treasury bonds sold off, stocks rallied hard. These developments were clearly predicated on the economy, not interest rates.

Rising rates hurt dividend-paying stocks by boosting borrowing costs. The most vulnerable are companies with hefty immediate refinancing needs. The good news is after two-and-a-half years of rock-bottom borrowing costs, only the weakest haven't been able to shore up their balance sheets.

Higher borrowing costs make it more difficult to grow, particularly in capital-intensive industries. That's not happening yet, as corporate borrowing rates remain very low and only basket cases-such as bankruptcy candidate Sprint Nextel (NYE: SS)-are paying up to issue bonds.

The real lesson of 2008 is that no matter how bad conditions get, inherently sound dividend-paying stocks inevitably recover, provided they hold their dividends, maintain balance sheet strength and keep plans for growth on track.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Once high-flying renewable energy stocks crashed and burned in 2011.

Last month, however, Sempra Energy (NYSE: SRE) locked in a 25-year contract to sell 150 megawatts of solar power to PG&E (NYSE: PCG). And by early 2013 it will harness 300 megawatts, all under lucrative long-term contracts.

California requires that regulated utilities double renewable energy use by the end of 2020, and 37 other states have similar laws.

That’s a huge opportunity for Sempra, particularly with rivals falling by the wayside.

All of the company’s operations beat guidance for 2011. These include regulated California electricity and natural gas distribution operations serving a combined 24 million customers; an Alabama gas utility; 2,300-plus miles of pipelines and related energy storage facilities; liquefied natural gas terminals; and utilities in Chile, Mexico and Peru serving 1.5 million users.

The hallmark of each is reliable cash flow with room to grow in coming years. Management lifted the dividend 23 percent in 2011 and a nearly 10 percent boost is expected this year.

Full-year 2011 profit covers the payout by better than 2.2-to-1, while cash in the bank covers 2012 debt maturities by nearly 2.4-to-1.

Sempra’s California utilities (45 percent of earnings) could see a cut in return on equity this year.

But even a worst-case would be more than offset by $12 billion in capital spending on smartmeters, pipeline upgrades and other programs popular with regulators and the public. That means few risks and robust potential growth for Sempra Energy.

Americans’ demand for electricity and communications services rises every year. Water use, in contrast, has been flat to falling in most areas. But the investment opportunity is no less compelling, as the country spends hundreds of billions to deal with degraded supplies.

The Environmental Protection Agency (EPA) estimates the US must spend at least $160 billion by 2020 to ensure safe drinking water supplies. That includes new pipelines and water mains to replace infrastructure built early in the last century as well as for treatment, storage and new sources. And that’s not including potential new treatment needs, such as for water used in hydraulic fracturing to produce natural gas.

That large cities’ water systems are increasingly at risk is no great revelation to anyone who lives in one. The information in the table “Dirty States,” however, is a bit more surprising.

In 10 states at least 15 percent of the population is served by systems that have violated at least one federal clean water law in the last 12 months. Five states have more than 20 percent of their population served by systems in violation: South Dakota, Missouri, Kansas, Oklahoma and Oregon.

The good news is the world’s water problems can be solved with money. Every pollutant that enters the water supply can be filtered out. Industrial processes can be changed, for example removing mercury from power plant emissions before it enters the atmosphere. Even water shortages can be alleviated with today’s reverse osmosis technologies that convert seawater into drinkable supplies.

The bad news is many water systems lack adequate funding. But therein lies the opportunity: Well-capitalized water utilities that make the needed investment and can earn a solid return--“spectacular” isn’t necessary--have a sure road to profit, almost no matter what happens to the economy or the rest of the stock market.

As businesses, the US water utilities in my portfolio universally entered and exited the 2008-09 market crash/credit crunch/recession with barely a scratch. As stocks they didn’t wholly escape, but damage was light and quickly reversed.

With fears of another recession running high, US water utilities are even better positioned on their fundamentals than in 2008. As a group, they have virtually no refinancing needs through the end of 2012. Payout ratios average well below 70 percent. Regulatory relations are strong, with only California a potential question mark for the future.

Average yields still rank the lowest in the US utility universe. But the best are growing dividends robustly--ensuring more of the same reliable total returns that have paced the group over the past decade and more. Aqua America (NYSE: WTR), one of our top picks at Utility Forecaster, has returned nearly 11 times as much as the S&P 500 since mid-2001. And these stocks are far less volatile than almost any other equities. You can uncover why my growth spotlight is on Aqua America here.

The result is a combination of superb safety, moderate but growing yields, low volatility and reliable long-term growth that’s tough to beat in these uncertain times. If you don’t already own a basket of well-capitalized water companies, now’s a great time to stock up. Check out this, this and this InvestingDaily.com article for more top picks from the water services industry.