| Published:
June 12, 2009
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
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 Dowcomponents 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. |
|
Company Name |
Current
Yield |
|
Kraft Foods
(NYSE: KFT) |
4.4% |
|
Caterpillar
(NYSE: CAT) |
4.4% |
|
Pfizer
(NYSE: PFE) |
4.5% |
|
Merck (NYSE:
MRK) |
5.9% |
|
DuPont
(NYSE: DD) |
6.1% |
|
Verizon
(NYSE: VZ) |
6.3% |
|
AT&T (NYSE:
T) |
6.8% |
|
|
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.
|
|
Company |
2008 EPS |
'09
Est. EPS |
Change |
|
Kraft
Foods |
$1.18 |
$1.91 |
+62.0% |
|
Caterpillar |
$5.66 |
$1.18 |
-79.1% |
|
Pfizer |
$2.42 |
$1.95 |
-19.4% |
|
Merck |
$3.42 |
$3.22 |
-6.0% |
|
DuPont |
$2.78 |
$1.75 |
-37.1% |
|
Verizon
|
$2.54 |
$2.54 |
0% |
|
AT&T
|
$2.81 |
$2.08 |
-26.1% |
|
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.
|
|
Discount to
Avg. P/E |
Dividend Growth
Rate |
Avg. Annual
Total Returns |
|
Kraft Foods |
-27.1% |
+10.6% |
+0.5% |
|
Verizon
|
-27.1% |
+3.3% |
+2.2% |
|
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
outgained 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.
Good Investing!
-- Carla
Pasternak
Editor
High-Yield Investing
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.
|
