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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.
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