Yield and Earnings Power
Dividend Coverage and Proven Track Record
Note from Cabot Wealth Advisory Editor Elyse Andrews: Occasionally, we bring you articles from guest editors that we think you will enjoy and benefit from. Today, you're going to hear from Carla Pasternak, Chief Investment Strategist of High-Yield Investing at StreetAuthority, as she discusses how to find the safest dividend in the S&P 500 Index. I hope you enjoy it!
Dozens of companies in the S&P 500 Index cut their dividends in 2009, equating to $52 billion in lost dividend income--the worst year on record for dividend cuts.
To put that figure in perspective, losing $52 billion would put Warren Buffett into bankruptcy. Thankfully, the draconian cuts that we saw in 2008 and 2009 seem to be on the way out.
Dividend increases are on the rise. According to Howard Silverblatt, an S&P analyst, payments among S&P 500 companies are expected to increase 5.6% this year. To celebrate this good news, I've decided to help you track down what I believe is the safest dividend in the S&P.
It's clear that dividend safety still has its place. In the first quarter of 2010, only two companies cut their payments--but those cuts were massive. Valero (VLO) cut its payment 75%, while Tesoro (TSO) completely eliminated its dividend.
To get us back on the right track and find the safest dividend in the S&P, I'm going to look at the same metrics used successfully to identify our past winners: yield, earnings power, dividend coverage and track record. Let's see what we uncover.
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Safety Criteria #1: Yield
When it comes to yield, it usually takes something above 6% to garner even a second look from me. So let's start with all the stocks within the S&P 500 that yield above that magic number.
As I suspected, it turns out the common stocks in the S&P 500 don't offer much in the way of yields overall, but you can still find a few individual companies offering attractive payments.
In total, 13 stocks in the S&P (only 2.6% of the total) yield 6% or more. Of those, the highest-yielding stock is Frontier Communications (FTR), which pays investors 9.6% a year.
With these stocks in focus, I'll now turn to my next metric to uncover the safest dividend in the S&P: earnings power.
Safety Criteria #2: Earnings Power
It's not uncommon for "sick" stocks to carry high yields. Based on a poor outlook, investors will dump the shares, boosting the yield. To combat this potential pitfall, I'm looking at the one-year growth in operating income for each of the 13 stocks with a yield above 6%.
Operating income is the profit realized from the company's day-to-day operations, excluding one-time events or special cases. This metric usually gives a better sense of a company's growth than earnings per share, which can be manipulated to show stronger results.
Given the downturn in the economy, I searched for companies on my high-yield list able to manage any growth in operating income during the past year, indicating the business was still able to thrive in one of the worst recessions in recent memory. After screening for positive one-year growth in operating income, I'm left with the four candidates shown in my table:
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Safety Criteria #3: Dividend Coverage
No measure of dividend safety carries as much weight as the payout ratio. By comparing the amount of operating profit earned against how much is paid in dividends, we can know whether a company can continue paying its current yield, even if conditions worsen.
For some of the payout ratios, I looked at earnings during the past year versus dividends paid. However, there are instances--such as with REITs--where depreciation expenses impact earnings, but are actually a non-cash charge and don't impact cash available for distributions. For this reason, I've calculated each by ratio by hand, using whatever metrics were needed to come to the most accurate ratio.
Safety Criteria #4: Proven Track Record
Looking into the track records of each of these companies offers good news for investors--each one has a solid history of paying (and raising) dividends. Depending on what you look for in an investment, I'd consider any one of the four to be the safest dividend in the S&P 500.
For example, Altria offers five-year annual returns of 12.2% and throws off a 6.8% yield. However, it is a manufacturer of cigarettes, which many investors choose to avoid.
Another option, Health Care REIT has offered annual returns near the 15% range during the past five years and hasn't had a dividend cut since they went public. This REIT invests in healthcare properties, which may be a more palatable alternative to Altria.
The final two stocks I uncovered, CenturyTel and Progress Energy, operate in two fields loved by income investors--telecoms and utilities. Both can be counted on to raise payments over the years, although CenturyTel definitely increases payments at a faster pace. In fact, the company just upped its payment 3.5% with the March dividend.
Chief Investment Strategist
P.S. If you like high yields, I've uncovered a rare opportunity to collect a 9.5% yield from a growing oil and gas company. Visit this link to find out how.