(MONEY Magazine) – LIKE MANY SMALL INVESTORS, YOU MAY STILL BE celebrating last year's 30%-plus returns on stocks and equity mutual funds. If you are, then we're sorry to say that the economy is down to its last bottle of wine; the party is just about over. Stock prices will likely turn in single-digit returns, at best, for 1996. There's still a way, however, that you can earn a double-digit total return over the coming year: Focus on the shares of large, established companies that pay relatively high dividend yields.

There's a convincing case that such stocks are the wisest choice for conservative small investors today. The economy may get a lift from the Federal Reserve's recent quarter-point reduction in short-term interest rates--especially if January's cut is followed by another later this year, as we think likely. Nonetheless, the Fed's rate reductions aren't big enough to offset the fact that the economy has been losing momentum for at least three or four months. "The latest data corroborate a forecast of slow growth but no outright recession," says Prudential Securities chief economist Richard D. Rippe. We agree. In fact, we expect growth of less than 2% in '96.

Such a slowdown means that many companies would fail to reach their profit targets over the next few quarters. As those subpar earnings are reported, investors are likely to mark down share prices quite mercilessly (to learn which stock groups are the most vulnerable, see Money Forecast on page 178). The risk of such earnings disappointments doesn't necessarily mean that you should shun high-flying growth stocks. If you're willing to ride out the ups and downs that volatile stocks will likely experience in the year ahead, you'll have the chance to scoop up great bargains, such as the 12 tech stocks we discuss in the story on page 112.

But if the prospect of even temporary losses makes you queasy, then you may want to concentrate on solid stocks paying above-average yields. Such shares are far less vulnerable to price declines than the typical stock is. Consider this: Since 1980, stock mutual funds have posted losses in 19 quarters. During those losing periods, equity income funds have given up only 3%, vs. 5.2% for the average equity fund.

More important, lowering your risk with yield stocks won't necessarily cost you a penny. Reason: In the long run, such stocks can outperform the overall market. For example, from 1975 through 1994, an index of equity income stocks compiled by BARRA, a stock market research firm in Berkeley, outpaced the S&P 500 by an average of 1.8 percentage points a year.

To find stocks that offer low risk and above-average returns, we started by screening 821 companies with yields of 3.3% or more. We narrowed those to three dozen based on size, financial strength and long-term growth prospects. Then we talked with more than 30 securities analysts to find today's best buys in eight different high-yield sectors and picked the most attractive one or two stocks in each. Here's a closer look at those stock groups, starting with the least risky:

WATER COMPANIES

Among utilities, companies that provide water generally have the most secure and predictable demand. After all, consumers would probably give up electricity, telephone service and even gas heat before they would forgo indoor plumbing.

Of the 59,000 water utilities in the U.S., fewer than 20 are publicly traded companies of any size. The biggest--and in most analysts' opinion the best--is American Water Works (ticker symbol: awk; recently traded on the New York Stock Exchange at $38.25, with a 3.6% yield). Thanks to an active acquisition program, over the past 10 years American has nearly doubled its revenues to an estimated $850 million for 1996.

Today the New Jersey utility serves more than 1.8 million customers in 21 states. As the company's expansion continues, it will grow faster than the average utility and can therefore afford to boost its stock dividend at a healthy pace, explains analyst Edward Tirello at NatWest Securities in New York City. "American Water Works has increased its dividend for 20 straight years," he says, "and is likely to hike its payout at least 6% annually." Tirello thinks the shares could gain 10% to $42 within 12 months; including the stock's current 3.6% yield, that would mean a total return of at least 13%.

NATURAL GAS DISTRIBUTORS

Not only is gas cleaner to burn and free of storage problems, it also can be 5% to 10% cheaper than oil. Result: "Customer growth for gas is 1.6% a year, compared with a slow decline in the number of customers who heat their homes with oil," says analyst Michael C. Heim at A.G. Edwards in St. Louis.

The holding company for Southern California Gas, $2.8 billion Pacific Enterprises (PET; NYSE, $28.25; 4.8%) ranks as the largest natural gas distributor in the U.S. with some 4.7 million customers, primarily in the Los Angeles area. In the 1980s, the company made an inept attempt to diversify. The worst move, according to Dean Witter analyst Foster Corwith: buying the Thrifty drugstore chain in '86, only to sell it in '92 at a billion-dollar loss. After that, PET decided to stick with the business it knows. "The company is focused solely on gas and is the lowest-cost provider in the area," he says, "and as a result earnings are heading up."

In addition, PET has a cash hoard of more than $300 million. "The company could start buying back stock this year and can easily afford to boost its dividend 6% in '96." He believes the stock could rise 10% to $31 within a year, for a return of almost 15%.

ELECTRIC UTILITIES

Long a favorite of retirees, electric companies are widely regarded as fusty investments that provide steady income but lousy total returns. Not true. A recent study by brokerage Duff & Phelps in Chicago found that over the past decade the top-quality electric companies the firm follows returned 14.3% a year on average, a mere half a percentage point below the S&P 500's average annual return. In the face of the market we foresee this year, passing up half a point to sharply reduce your risk could be quite a smart trade-off.

Duff & Phelps' top picks right now include $8.6 billion SCE Corp. (SCE; NYSE, $18.25; 5.5%). The parent company of Southern California Edison, SCE serves 4 million customers in central and southern California. Over the past two years, the stock has been depressed by at least 10% because of the company's high operating costs and wrangles with state regulators. Recently, however, the outlook has improved greatly, says Duff & Phelps analyst Joyolin Brown. "The company has settled most of its regulatory problems," she says, "and now SCE can catch up to the industry in cutting costs." Brown thinks the stock could move up about 10% to $20 within a year; including the yield, that would be a 15% total return.

Nathan Partain, also of Duff & Phelps recommends $1.6 billion Boston Edison (BSE; NYSE, $29.50; 6.3%), which provides electricity to 660,000 people in eastern Massachusetts, because it stands to benefit from an improving regulatory climate as well. "This is the East Coast version of what's happening with SCE," says Partain. He also notes that the company plans to trim costs by eliminating 300 jobs (out of 3,800) this year. Partain figures the share price could rise 9% to $32 over 12 months for a 15% total return.

OIL COMPANIES

"Over 10 years or so, international oil stocks earn an average annual return of 15% or more," says analyst Constantine Fliakos at Merrill Lynch. "And I think they could do even better in the coming decade."

Fliakos particularly likes $145 billion Royal Dutch Petroleum (RD; NYSE, $140.25; 3.9%), the majority owner of the Royal Dutch/Shell group, which he believes can boost oil and natural gas production by 5% a year. In addition, the company's financial strength is exceptional--cash holdings of more than $13 billion are enough to pay off its total debt. Fliakos thinks the stock could climb at least 11% to $155 over the next 12 months for a 14% total return.

Analyst Paul Ting at Salomon Bros. favors $114 billion Exxon (XON; NYSE, $81; 3.7%). "The company earns the highest return on its capital of any major oil and normally carries a premium price," he says. Currently, however, the stock is only trading on a par with its competitors. Ting expects the stock to recover at least part of its historical 10% premium relative to other oils. He therefore calculates that the shares could rise 14% to $92 within 12 months, for a 17% total return.

CONGLOMERATES

In the 1960s, business consultants came up with the notion that by bundling together several unrelated businesses, a conglomerate could achieve steadier earnings growth than if its profits were tied to the ups and downs of a single industry. Unfortunately, most of those companies turned out to be disjointed monsters that were impossible to manage.

Nonetheless, conglomerates can be excellent values when they shed businesses with limited potential and sharpen their focus. For example, over the past year $11.6 billion American Brands (AMB; NYSE, $45.25; 4.4%) sold off its U.S. tobacco operations and several other businesses. Then in January, the company bought Cobra Golf, a maker of oversize golf clubs, for $700 million. Analysts figure that new business will fit well with American Brands' Titleist golf club line. "Following the acquisition, American Brands would have the No. 2 position in golf clubs, with a 20% share of the $2 billion wholesale market," says analyst Robert Leininger at Gabelli & Co. in Rye, N.Y. He thinks the stock could rise at least 12% to the low $50s over the coming year for a 17% total return.

REITs

Real estate investment trusts (REITs) own a variety of residential or commercial properties. In addition to paying high current yields, they are often excellent inflation hedges because real estate values typically move up with increases in consumer prices.

One of the REITs that analysts rate most highly right now is Kimco (KIM; NYSE, $26; 6%), which has assets of $899 million and owns 174 small shopping centers, mostly in Florida and the Midwest. This past Christmas was the worst for retailers in five years, which hurt many REITs that own shopping centers. In fact, says analyst Gregory J. Whyte at Dean Witter, "The retailing environment has been deteriorating over the past five years." As a result, many REITs that own retailing properties are undervalued by as much as 15%. Nonetheless, Whyte thinks Kimco is due for a rebound. His reasons: Rents are rising on the company's well-located properties. In addition, Kimco is strong financially and generates so much cash that it can afford to raise its dividend 8% to $1.68 this year. Whyte sees the share price rising 8% to $28 within the next 12 months, for a total return of nearly 14%.

FINANCIAL SERVICES

Another quarter-point interest-rate cut by the Fed would boost the value of the chief assets held by financial services companies--bonds and other IOUs--while reducing the cost of their chief raw material--namely money.

In the past year, Mellon Bank (MEL; NYSE, $52.25; 4.2%), assets of $41 billion, has taken three giant steps that are likely to improve its outlook. Last year the company wrote off more than $100 million in bad loans that resulted from an unsuccessful program in its otherwise strong credit-card business. "It was a staggering number, but the bank moved aggressively to fix the problem," says Merrill Lynch analyst Livia S. Asher. Further, the bank has used its excess cash to buy back nearly 8 million shares and will likely repurchase even more. In addition, over the past year Mellon has boosted the assets at its underachieving Dreyfus money-management subsidiary by more than 15%. Asher figures the stock could rise to the mid-$60s over the next year, a gain of at least 20% from here and a 24% total return.

Stock buybacks and successful acquisitions have improved the outlook for profit growth at American General (AGC; NYSE, $37.25; 3.3%), a leading insurer with assets of $61 billion. In addition to annuities and life insurance, American General has a $8.4 billion credit-card and consumer-lending business. "The company reserved an additional $216 million against bad loans last year, which removes a major cause of uncertainty," says Dean Witter analyst Michael Lewis. Analyst Joan Zief at Goldman Sachs, who also likes American General, figures that the stock could rise 13% to above $42 over the next year, for a 16% total return.

A SPECIAL SITUATION

It's rare that a high-yield stock provides much excitement, but one company that passed our screen looks like an attractive special situation. In January, $5.4 billion Dun & Bradstreet (DNB; NYSE, $65; 4.1%) announced its intention to split into three separate companies by fall.

Dean Witter analyst James D. Dougherty sizes up the three prospective stocks as follows: The new Dun & Bradstreet (consisting of the credit rating service, Moody's investment rating agency and R.H. Donnelly, a publisher of Yellow Pages) would be worth about $34 a share. Cognizant Corp. (including the service that compiles the Nielsen ratings for broadcasters and suppliers of marketing information to high-tech and health-care businesses) could command $44 a share. And A.C. Nielsen, which does market research for consumer products, would go for $9 a share.

"After the split-up, the three pieces could total about $87, or 34% above the current price," says Dougherty. Analysts expect the yield on the three stocks to be less than it is on the current shares. But even so, the total return for investors could run 36% over the next 12 months. For conservative investors, that kind of return in '96 will doubtless look golden.