Editor’s Note: I know many of you enjoy reading analysis of dividend-yielding stocks. Therefore, I am pleased to share with you this great article from Carla Pasternak.
Carla writes the Dividend Opportunities newsletter for our partner, StreetAuthority, and has some good insight on yields for the stocks within the Dow Jones Industrial Average.
-Charles Rotblut, CFA
Senior Market Analyst, Zacks.com
The 30 stocks in the Dow Jones Industrial Average ($DJI) sport some attractive yielding stocks — many with more than twice the average yield of the S&P 500. But the question is: Which company has the safest dividend in the Dow?
General Electric’s (GE) double-digit dividend yield looked pretty juicy a few months ago — that is, until they slashed it by -68%. And Citigroup (C), which recently got kicked out of the Dow, had a once-rich yield. Now its quarterly dividend payment stands at one lonely penny per share.
But rest assured, there are still plenty of solid Dow dividend payers — companies that should continue to deliver yields of 6% or more for years to come. And I’ve sorted through the blue-chip index and applied several stringent criteria to arrive at the safest one.
Following last year’s dismal market performance, investors are understandably cautious. Both Wall Street and Main Street are looking for something they can be sure of in the year ahead. And for income investors, that means finding a safe and rewarding dividend yield.
It used to be that dividend payers themselves were the thing investors could be sure of. Tucked in the shadow of more aggressive and volatile Wall Street darlings, these venerable firms conducted their business, generated solid cash flows, posted their earnings and paid their dividends.These companies all made money the old-fashioned way. They earned it. High-flying? No. Dependable? Yes.
But last year was a tough year for dividend payers. Sixty-one of the companies in the S&P 500 Index cut their dividends in 2008, equating to $40.6 billion in lost dividend income. But it’s time to apply last year’s hard lessons and take a clear-eyed look at risk, performance strength, dividend coverage and, lastly, potential return.
The Dow Jones Industrial Average represents some of the strongest names in America. The 30 members of the Dow are worth a collective $2.83 trillion and are considered to be the market leaders in their industries.So these corporate titans are a good place to start searching for the safest dividend.
Safety Criteria No. 1: Yield
| Company Name | Current Yield |
| Kraft Foods (KFT) | 4.4% |
|
Caterpillar (CAT) |
4.4% |
| Pfizer (PFE) | 4.5% |
|
Merck (MRK) |
5.9% |
|
DuPont (DD) |
6.1% |
|
Verizon (VZ) |
6.3% |
|
AT&T (T) |
6.8% |
The first step in the process is not to look at the Dow at all, but to start with the 10-year Treasury note, currently yielding 3.86%. In theory, stocks represent more risk than Treasuries, so you want to make sure you’re getting compensated for that risk with a higher yield.
Using the yield of the 10-Year Treasury as our threshold eliminates most of the Dow. Though the Dow
components pay an average dividend yield of 3.3%, about 40 basis points higher than the S&P 500 Index, our chart shows that only seven Dow components yield more than the 10-Year Treasury.
Safety Criteria No. 2: Performance Stability
Next, I want to be sure the outlook for the company is stable. If there is notable trouble on the horizon, one place it will show up is in a company’s projected earnings. For the purposes of this analysis, I’ll shy away from any company expected to show more than a -5% decline in earnings this year, based on the consensus Bloomberg estimate.
|
Considering the challenges of the current economic environment, it’s not surprising that this analysis takes five more companies out of contention.
We’re left with just two firms: Kraft and Verizon.
Safety Criteria No. 3: Dividend Coverage
Remember, safety is the first and most important criteria I look at when examining a dividend-paying stock.With that in mind, I decided to look into the most recently reported quarter for each company and compare net earnings to total dividends paid. We must exclude any company that paid more in dividends than it earned. That sort of arrangement is unsustainable. Any company whose dividend costs exceed its net earnings lacks the margin of safety that conservative income investors in this market must demand.
This is a tough hurdle to clear:The first quarter of 2009 presented extremely difficult operating conditions.Any company able to comfortably maintain its distributions in such a challenging environment clearly has demonstrated a wide economic moat.
Here are the results:
Kraft earned $662 million and paid out $426 million for a payout ratio of 64.7%. Verizon earned $1.6 billion against its $1.3 billion dividend obligation for a payout ratio of 79.4%.
Safety Criteria No. 4:Track Record and Upside Potential
We’re still left with two companies. Both Kraft and Verizon have above-average yields, have a stable outlook and have demonstrated an ability to cover their dividends under tough economic conditions.
At this point, I’ll turn to history as a guidepost, looking at each company’s average P/E, dividend growth rate and average annual total returns for the past five years.
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Amazingly, both companies are trading at almost identical discounts to their five-year average P/E. If each stock returned to its average P/E, Verizon would appreciate +37.1% while Kraft would appreciate +37.2%. Apparently that’s not going to break a tie.
Verizon does yield 1.9% more than Kraft, although Kraft has grown its dividend at a faster rate. Both companies also outperformed the S&P 500’s annualized total returns for the past five years. But Verizon out gained Kraft by +1.7% a year — by almost the same amount as its dividend premium over Kraft.
As a telecommunications provider, Verizon is an essential service with high subscriber loyalty. Kraft Foods includes strong consumer food brands like Kraft cheeses, Oscar Mayer meats and Nabisco cookies. Both companies boast of above-average yields and both dividends passed my stringent safety criteria.
If pressed, I’d have to tip the scale to Verizon for the safest dividend in the Dow. Its higher 6.3% yield has made a positive impact on its total returns. And that difference is something we income investors can take to the bank.
— Carla Pasternak
Editor, Carla Pasternak’s Dividend Opportunities
P.S. I know of one stock whose yield is even higher than
Verizon’s — and just as secure. I’ve been recommending this security to my
readers for years, and it has rewarded us handsomely. Right now it’s yielding a
hefty 9.5%. But the best part about this stock is that it pays monthly… AND
it’s never cut its dividend.
Go
here to get the full story on this stock now.
