"The 10 best income stocks," the headline for this piece trumpets. I certainly intend to deliver on that promise. Before this column is over, you will find a list of what I believe are the 10 best income stocks to buy now.

But a minor piece of business first: What exactly characterizes the best income stocks now? Let's take that concept apart piece by piece to see what we're looking for.

Best income means most income, but it also means reliable and rising income. At a minimum, any "best" income stock should yield more than the 2.8% offered by the two-year Treasury note now. An investor willing to hold that Treasury note to maturity is safe from any likely increase in interest rates because the note will return the investor's capital at maturity. Even the safest stock is riskier than that and should pay more.

But best income also must be reliable. The company must be able to pay that dividend this year and next year and the next, just like a bond does. For example, Net Perceptions ( NETP carries a dividend yield of 192% based on its Sept. 3, 2003, payout of $1.50 a share in dividends and a recent share price of just 83 cents.

But nobody should count on Net Perceptions paying out any dividends ever again. The company is in the midst of a bitter liquidation battle and is appealing a Nasdaq order to delist the stock. The $1.50 payout last September was, as the company said at the time, a return of investors' capital and not a dividend paid from profits.

And because this isn't a bond, my definition of best income also includes rising income. An investor who continues to hold stock in a company that increases its dividend over time will receive an increasing cash flow from that original purchase each year. That way, investors have the magic of dividend compounding working in their favor.

Best income stock means, at worst, a stock that doesn't fall in value; at best, it means it appreciates in price. Nobody should expect that even the best stock will never fall. What counts is that the price is stable or better over some reasonable period, say two years to match the two-year maturity of our benchmark Treasury note. The best income stock will be stable enough so that the investor willing to hold for two years has a very good chance of seeing a return of the original invested capital.

"Best income stock now" means the stock in question is well-suited to the current and reasonably foreseeable future. At the moment, that means rising but not runaway inflation, and rising but not runaway interest rates. This argues in favor of companies that own tangible things that will go up in value with inflation. I'd put land, oil and gas reserves, copper, nickel and iron deposits, energy infrastructure, timber and the like in this category. It argues against companies that depend on borrowing to increase their revenue and earnings and that use leverage to increase their earnings and cash flow. Many limited partnerships in the energy sector and many real estate investment trusts fall into this category.

My Top 10

Rising interest rates means it's time to look for growth-oriented income stocks. You don't have to do it overnight. With the first reading on growth in second-quarter gross domestic product coming in at 3% Friday, below the consensus forecast of 3.7%, interest rates aren't about to zoom higher. But they will be higher in 2005 than they are now, and income investors ought to reposition all or part of their portfolios accordingly.

OK, now to my list (in alphabetical order) of the 10 best income stocks now.

BP ( BP - Get Report): It makes this list over ExxonMobil ( XOM because of its higher dividend yield (3% to 2.4%) and over other oil majors because, thanks to its Russian joint venture, the company is virtually assured of reaching its goal of increasing output by 5% a year for the next five years. The company raised its dividend to 42.6 cents per ADR from 40.5 cents when it reported second-quarter results July 27.

Citigroup ( C - Get Report): A bank? What's it doing here? Well, how often do you get to buy one of the world's great banking franchises with a 3.6% yield? Everyone knows that bank stocks will get hammered when interest rates rise, which is why Citigroup's stock is down 8.5% in the last six months. But if you're willing to hold for two years, as I outlined above, you're just about guaranteed the safe return of your capital. The bargain is likely to get even better later this year and into 2005, so you might want to wait on this one before you buy.

FPL Group ( FPL - Get Report): In its July 23 second-quarter earnings report, the company said it was highly confident that 2004 earnings per share would fall between $5.05 and $5.15 and confident that earnings momentum will continue into 2005. But that confidence seems a lot more convincing to me because the board at this Florida utility holding company voted to increase the dividend by 10% to 68 cents a share from 62 cents for shareholders of record as of Aug. 27. The stock now yields 4.1%.

Plum Creek Timber ( PCL: The company raised its quarterly dividend to 36 cents from 35 cents a share on July 27. This is a sign that the timber and forest-products company is succeeding in its drive to realize more of the value of its 8.1 million acres of timberlands by selling selected acreage into the real estate market. The stock now yields 4.6%.

Progress Energy ( PGN: The company supplies electricity to fast-growing markets in Florida and the Carolinas, so it has the same kind of demographic trends filling its sails as Florida's FPL. But the stock carries a higher dividend than FPL, 5.3% to FPL's 4.1%, because Progress Energy is still very much a work in progress. For example, the company has a large railcar division that doesn't fit in with the rest of the business and has underperformed. The company plans to sell it, but until that deal goes through, the railcar business is a drag on the stock price.

Rayonier ( RYN - Get Report): Rayonier's two core businesses are turning trees into wood products and performance fibers, and managing and selling its timberland. The stock yields 5.1%, extraordinarily high for the timber industry, thanks to its structure as a REIT after a January conversion. Rayonier has increased its dividend by about 5.5% annually over the last five years. On July 28, Rayonier reported second-quarter revenue growth of almost 14% from the year-earlier period.

San Juan Basin Royalty Trust ( SJT - Get Report): This company doesn't do much of anything -- except pay dividends. As a royalty trust, it collects royalties on oil and gas pumped from its lands in New Mexico. Burlington Resources ( BR does the actual pumping. The trust's monthly payments vary with the price of natural gas, so owning this stock is a pure play on rising natural gas prices. The stock carries a 7.1% dividend yield, but that comes with some interesting wrinkles. Trust owners get a tax credit due to the kind of gas pumped from the company's land. Payouts aren't taxed until the shares are sold because of the way that energy-depletion accounting works. Investors should also note that San Juan is a self-liquidating company: It has only a limited amount of gas, and once that's gone, so are the distributions. Estimates are that the gas should last another 15 to 20 years.

Texas Pacific Land Trust ( TPL - Get Report): This trust works just about the same way that the San Juan Basin Royalty Trust does, except that instead of collecting and distributing royalties from oil and gas, Texas Pacific collects the proceeds from selling some of the 1 million acres of land it owns in western Texas each year and then uses that cash to buy back shares. (Texas Pacific also collects oil and gas royalties on almost 400,000 acres of Texas land and receives other cash flow from the fees ranchers pay to graze cattle on its land.) Because very little of the company's cash goes to paying a dividend (the yield is just 0.7%), investors get their income in the form of a steady appreciation of the company's share price as it buys back more shares, decreasing shares outstanding.

TransCanada ( TRP - Get Report) owns 24,000 miles of pipeline that move the majority of western Canada's natural gas to markets in Canada and the U.S. This makes the company a long-term play on the growth of Canadian gas production and its increasing importance to the U.S. market. The recent acquisition of the Gas Transmission Northwest Corp., expected to be finalized by the fourth quarter, will extend TransCanada's system from British Columbia into California. The stock yields 4.3%.

UGI Corp. ( UGI - Get Report): It's a holding company that distributes propane through AmeriGas Partners and conducts its utility business through subsidiary UGI Utilities. The company just increased its dividend effective with the July payment. This 9.6% hike to an annual $1.25 a share marks the 17th consecutive year that UGI has raised its dividend. The company has paid a dividend on its common stock for 120 years. The stock now yields 3.9%.

The goal in each of these 10 income stocks is total return, a measure that combines price appreciation and dividend payouts. So, for example, UGI, which yields 3.9%, has posted an average annual total return of 13.5% over the last 10 years.

Past performance is, as they say, no guarantee of future results, but with interest rates and inflation both threatening to move higher in the next five years, growth income stocks like these have the best chance of taking income investors to their goals.


Please note that due to factors including low market capitalization and/or insufficient public float, we consider Net Perceptions and Texas Pacific Land Trust to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: BP and Rayonier. He does not own short positions in any stock mentioned in this column. Email Jubak at jjmail@microsoft.com.