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Investors have heard it thousands of times: Dividends are the way to make money in the stock market. Get paid to wait.

But this is easier said than done, especially when investors count on a significant income stream that will rise, at least, at the rate of inflation, and when that has been hard to find in recent years.

When most Canadians think dividends, they think of the big banks. But none of the Big 5 have raised their dividends in the past two years. And the share prices of the titans of Bay Street have been stuck in neutral.

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Dividend-paying stocks took a back seat to income trusts for several years as the choice of investors looking for yield. But Finance Minister Jim Flaherty effectively put an end to that investment vehicle with his "Hallowe'en Surprise" in 2006, so dividends are back in the spotlight.

What is the dividend-seeking investor to do? Let's consult the experts.

Only a handful of mutual funds in the Canadian dividend and income equity category rose in value by more than 20 per cent last year. And they took very different paths to achieve their performance.

He Likes Oil

Jeff Hall, manager of Investors Group's Canadian Equity Income Fund, oversaw the fund as it gained more than 23 per cent in the past year. Mr. Hall has been managing Investors' Canadian Equity Income Fund since its inception five years ago. He notes the fund began as primarily an income trust vehicle.

"Avoiding the torpedoes has been a key focus for my funds," says Mr. Hall. To do that, he says it's important not to just look for companies with the highest-paying dividends. "If you're thinking a 15 per cent payout is sustainable, you should adjust your expectations."

A look at the most recent holdings of Mr. Hall's fund shows oil, oil and more oil at the top of his list. He has several reasons, including his bullish view of the North American economy and oil prices, and the continued decline of the U.S. dollar.

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Mr. Hall also likes real estate investment trusts. "We have a robust position in the REITS," he says. "They have stable distributions, and their balance sheets are fairly conservative. I don't foresee a rapidly rising interest-rate environment that would impair their valuations any time soon."

The banks are conspicuous by their absence in his top holdings. But that doesn't mean he has ruled them out. Mr. Hall says he sees adding more large-cap names this year as a means of diversification. While "you can't stay in love with the oils forever," he says, he still does rate banks in his top 10 for growth potential.

She Likes Banks

One fund manager with less aversion to the banks is Jackee Pratt of Matrix Asset Management. The Matrix Monthly Pay fund she manages was another top performer last year. The most recent reading of the fund's holdings shows three Canadian banks at the top of her list. Ms. Pratt's fund has a weighting of about 13 per cent in banks, and a whopping 27 per cent in financials (including REITs.)

The growing effect of China's booming economy is a major theme for Ms. Pratt. It has led her to resource plays that are paying dividends - larger names such as Teck Resources and Potash Corp., as well as energy equities, particularly high yielding names coming out of the income trust space, such as ARC Resources, Bonavista Energy Trust and Penn West Energy Trust.

Ms. Pratt has advice for individuals investing in dividend-paying stocks. "Know how to value the companies. And diversify. Don't leave yourself exposed to one or two companies."

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Research is a key part of the philosophy for Sentry Select Capital Corp. "I have relatives who spend hours crunching numbers for their fantasy sports leagues," says lead manager Sandy McIntyre, "but wouldn't know how to analyze a balance sheet or income statement."

Sentry's Growth and Income Fund gained more than 21 per cent in the past 12 months. The fund's top holdings include American companies such as garbage transporter Republic Services and Canadian companies not often found in dividend funds, such as Telus, Viterra Inc. and Cargojet Income Fund. "We don't believe we can do better analysis of the TSX60 companies," Mr. McIntyre says. "So we focus on names that are under-owned and manage to outperform that way. And we also have to be trading better than the mope in the next tower."

Good for Mature Investors

Mr. McIntyre says it's important for people to grasp what debt means, what equity means, and to look for consistent long-term growth in dividend payments. He is a big believer in dividend investing, especially for mature investors. "As you get older you need a strong, reliable flow of income, because you generally won't be able to increase your capital base."

A happy side benefit of dividend investing is that dividend-paying companies often end up growing and appreciating in share price faster and more consistently than supposed high growth companies. "Having a dividend policy imposes discipline on companies," says Aubrey Hearn, one of the co-managers of Sentry's Growth and Income Fund. "They don't waste their capital on things like silly acquisitions or needless expansions that don't make sense."

Mr. Hearn specializes in U.S. equities. One of his favourites is Becton Dickinson, a maker of syringes, needles and catheters. "It has 30 plus years of dividend growth," says Mr. Hearn. "Health care is out of favour, but this company won't be hurt - it's growing all over the world, and has 60 to 70 per cent market share."

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He also likes Microsoft as an out of favour value pick.

Jeff Hall is also the head of the Fixed Income Team at Investors Group, which includes managing a high yield bond fund. He says there's an analogy in that sector that can apply to all income investing.

"Life is great for the turkeys on the turkey farm, right up until the day before Thanksgiving. Then the end can be pretty sudden and violent," he says.

The lesson: do your homework on anything you invest in to avoid the companies that may bring a sudden and nasty surprise, and diversify so any one loss won't leave a bad taste in your mouth.

Special to The Globe and Mail

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