NEW YORK (CNN/Money) - Dare we say it? -- stocks that pay dividends are now cool. In this volatile market, there's nothing wrong with owning a stock that will actually give you a little something back each quarter.

But there's another reason to like dividend-paying stocks. Companies that have been able to keep paying dividends in this unstable environment -- and especially those that have hiked their payouts -- are usually financially sound.

"If companies are able to increase dividends, then the probability is that earnings growth is fairly consistent," says John Snyder, manager of theJohn Hancock Dividend Performers Fund.

To be sure, some high-yield stocks are real snoozers. If you just want the income, utility stocks and real estate investment trusts (REITS) pay above-average yields -- but don't expect much by way of capital gains.

Similarly, sometimes a high yield is actually a red flag. The yield is determined by dividing the annual dividend by the stock price. If the stock price crashes, the yield will be extra-large. There's just one problem: If the stock crashed because the company is in trouble, don't be surprised if the dividend soon gets cut too.

"Investors could get in trouble in the search for yields by buying a stock that has a high yield only because the stock price is going down," says Linda Duessel, manager of the Federated Equity Income Fund. Struggling fiber-optic cable manufacturer Corning (GLW: Research, Estimates) suspended its dividend last year and United Airlines (UAL: Research, Estimates) did so following the Sept. 11 terrorist attacks. Big Three auto makers Ford (F: Research, Estimates) and DaimlerChrysler (DCX: Research, Estimates) both recently cut their dividends.

In the search for so-called "strength stocks," we looked for companies with above average dividend yields but also expectations of double-digit earnings growth. "I'd rather have something with a 2 percent yield and earnings growing at 12 percent than something yielding 4 percent and earnings growing at 1 percent," says Snyder.

Then we made sure that the dividend has been increasing over the last three years. Finally, we looked only at companies that are paying less than 50 percent of their earnings in the form of a dividend. While having a high dividend is certainly nice, it's even better if the company can retain a good chunk of its earnings as well in order to finance research and development, acquisitions or other strategic plans that can help boost growth.

Here's who made the cut.

The financial services sector typically does well in the initial stages of an economic recovery. But most financials also pay decent dividends, making them more attractive. Two companies in particular that have strong, growing yields and solid growth prospects are Washington Mutual and Wells Fargo.

Although Washington Mutual (WM: Research, Estimates) is a savings and loan (also known as a thrift) and Wells Fargo (WFC: Research, Estimates) is a commercial bank, the two companies are actually very similar. Both are a major presence in the mortgage lending market, a business that thrived during last year's refinancing boom.

Interest rates may rise later this year, but the companies are also the two largest servicers of mortgages (servicers collect monthly payments and handle escrow accounts). So Washington Mutual and Wells Fargo will continue to benefit because they will be able to hold onto existing loans longer and collect a steady stream of fees.

Both companies announced dividend increases in conjunction with their first-quarter earnings reports and each is yielding more than 2 percent. And the two stocks are trading at attractive valuations. Washington Mutual is valued at just 10 times 2002 earnings and earnings, with earnings expected to increase 11 percent this year. Wells Fargo trades at 15.6 times 2002 estimates, with earnings expected to rise at a nearly 13 percent clip over the next three to five years.

Healthcare is another sector that features solid growth in earnings and dividends. Drug giant Merck, for example, has increased its dividend every year for the past fifteen years. Merck's dividend yield of 2.5 percent is a full percentage point higher than the S&P 500's average.

The company is struggling, with worries about patent expirations and concerns about links between its arthritis drug Vioxx and heart problems. The stock is down 5 percent this year but it is still in good shape, as earnings are expected to increase in excess of 10 percent over the next five years.

Merck (MRK: Research, Estimates) has 11 drugs set to hit the market between now and 2006. Another positive sign is that Merck has filed to sell its low-margin pharmacy benefits management business Merck-Medco in an initial public offering later this year. Merck-Medco accounted for more than half of Merck's revenues less year but only ten percent of net income.

Another healthcare stock with a steadily growing dividend is Owens & Minor (OMI: Research, Estimates), a distributor of surgical equipment. The company increased its quarterly dividend by a penny last week following a 32 percent increase in first-quarter earnings. The stock trades at just 16 times 2002 earnings estimates even though earnings are expected to increase 24 percent this year. The dividend yield is 1.6 percent.

Food stocks have been a solid performer during the economic downturn. The group could cool off as investors seek out more cyclical stocks as the economy continues to recover. But there are still several food stocks with appetizing earnings growth prospects and solid dividend growth that are worth considering for a diversified portfolio.

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Hormel, known mainly (and perhaps infamously) for making the canned luncheon meat Spam, is one such food stock. Although Hormel (HRL: Research, Estimates) issued an earnings warning for the second quarter due to a Russian ban on poultry imports, earnings are still expected to increase 8 percent this year and 10.4 percent a year over the next three to five years. The company increased its dividend in February, marking the 36th consecutive year that Hormel's dividend will be higher than the previous year.

And if you need some salt and pepper for that Spam, (we don't blame you) enter McCormick (MKC: Research, Estimates). The company is one of the leading manufacturers of spices and seasonings. Earnings are expected to increase 18 percent this year and the stock has paid a dividend for the past 78 years. The dividend has increased by 7.7 percent over the past three years -- pretty tasty.  

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