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The Safest Dividend in the Dow |
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-- By
Andy Obermueller |
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A number of dividends in the Dow Jones Industrial Average are
looking pretty juicy these days. Pundits have been debating
whether the highest-yielding Dow component, General Electric, will
continue its hefty 10.9%
payout. Though the company has promised to stand by its
obligation to shareholders, you can see why some investors --
given last year's drubbing -- are less likely to take such a pledge
at face value.
So the question is appropriate: Which company has the
safest dividend in the Dow? We sorted through the blue-chip
index and applied several stringent criteria to arrive at the
surprising answer. (Full Story Below) |
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The Safest Dividend in the Dow
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Anyone
looking for a motto for 2009 need look no further. The
catchphrase for the year, at least for income investors, has
to be "safety first." Following last year's dismal
performance,
investor caution has morphed into anxiety. Wall Street and
Main Street are both looking for something they can be sure
of.
It used to be that dividend payers themselves were the
thing investors could be sure of. Tucked in the shadow
of the Wall Street darlings, these venerable firms conducted
their business, posted their earnings and paid their
dividends. These companies all made money the
old-fashioned way. They earned it. High-flying? No.
Dependable? Yes.
Well, we all saw what happened -- last year was a
terrible year for dividends. So now 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.
We'll start by setting the bar high, with some of the
strongest names in America. The 30 members of the Dow Jones
Industrial Average are worth a collective $2.74 trillion and
are considered the strongest in their fields. We'll
sift through these corporate titans to find the absolutely
safest dividend.
Safety Criteria No. 1: Yield
The first step in our process is not to look at the
Dow at all, but to peek into the debt
market, where a 10-year "AAA"-rated bond pays
4.9%. If we can't beat that cash return with a
stock, then we might as well stick with the ultra-safe bonds.
This eliminates most of the Dow. Though it pays an
average dividend of 3.9%, about 50 basis points higher than the S&P 500 Index, only eight Dow
components yield more than the "AAA" bond. They are shown in the chart.
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Company Name |
Current Yield |
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Merck (NYSE: MRK) |
5.0% |
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Caterpillar (NYSE: CAT) |
5.6% |
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Verizon (NYSE: VZ) |
5.8% |
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J.P. Morgan Chase (NYSE: JPM) |
6.3% |
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AT&T (NYSE: T) |
6.5% |
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DuPont (NYSE: DD) |
7.0% |
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Pfizer (NYSE: PFE) |
8.4% |
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General Electric (NYSE: GE) |
10.9% |
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Safety Criteria No. 2: Performance Strength
Next, we're going to borrow a page from our colleagues
in the value investing world. They recommend focusing on
companies with rising, or at least steady, earnings. To that end, we will shy away
from any company expected to
show more than a -5% decline in earnings this year, based on
the consensus Bloomberg estimate.
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Company |
2008 EPS |
'09
Est. EPS |
Change |
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Merck |
$3.29 |
$3.29 |
0% |
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Caterpillar |
$5.66 |
$2.49 |
-56.0% |
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Verizon |
$2.54 |
$2.54 |
0% |
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J.P. Morgan |
$0.98 |
$1.80 |
+83.7% |
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AT&T |
$2.81 |
$2.71 |
-3.6% |
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DuPont |
$2.78 |
$2.04 |
-26.6% |
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Pfizer |
$2.42 |
$2.27 |
-6.2% |
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General Electric |
$1.93 |
$1.27 |
-34.2% |
This eliminates four companies that are estimated to show
appreciable declines in earnings this year.
We're left with four firms: Merck, J.P. Morgan, Verizon
and AT&T.
Safety Criteria No. 3: Dividend Coverage
Remember, safety is first. With that in mind,
we're going to look into the most recently reported quarter
for each company and compare net earnings to total dividends
paid. This is a tough hurdle to clear: The
second half of 2008 presented extremely difficult operating
conditions. Any company able to maintain its
performance in such a punishing environment clearly has
demonstrated a wide economic moat.
Here are the results:
Merck recorded $1.1 billion in net earnings and paid $808
million in dividends.
J.P. Morgan Chase earned $702 million and paid $1.4 billion
to its shareholders.
Verizon came close to meeting its dividend, but couldn't
fund it from operations. It earned $1.24 billion and dipped into its pocket to come
up with part of its $1.30 billion dividend.
AT&T earned $2.40 billion and paid out $2.35 billion.
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.
Safety Criteria No. 4: Upside Potential
We're left with two companies, Merck, the drug maker
whose dividend amounted to 73% of its net earnings last
quarter, and
AT&T, whose earnings covered its dividend with $50 million
to spare.
Certainly at this point it's worthwhile to revisit our initial
criterion and simply ask which company has the highest
yield. It's AT&T, whose payout exceeds Merck's by
150 basis points. Now, even though that's a wide margin, we
want to be sure we aren't missing out on potential upside.
We'll use that as our tiebreaker.
AT&T shares are trading at roughly
nine times its trailing
earnings of $2.82 per share. A return to its five-year
average multiple of 14 would mean a share price of almost $40 --
+55% higher than the current price. Throw in the 6.5% dividend
and the best-case scenario for investors is a total return
of +62% based on Tuesday's closing price.
Merck, for its part, typically sells for
nearly 14 times
earnings. The market is currently valuing the shares at
nine
times TTM earnings of $3.35. If Merck returns to its historical valuation, the capital gain would amount to +55% for a total gain above +60%.
Based on these
criteria, AT&T can be considered not only the strongest
dividend in the Dow, but also the dividend payer with the
greatest total upside -- though the race was extremely
close. A 6.5% dividend is respectable -- but the real
opportunity with AT&T is to be paid an extremely safe rate
of return while waiting for a robust capital gain.
Many happy returns!
Andy Obermueller
Co-Editor
Global Dividend Opportunities
GlobalDividends.com
839-K Quince Orchard Blvd.
Gaithersburg, MD 20878-1614
P.S.
-- Don't miss a single issue! Add our address,
Research@GlobalDividend.com,
to your Address Book or Safe List. For instructions,
go
here.
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Notes
The yield on the S&P 500 (3.4%) is higher than
the yield on 10-year Treasuries (2.9%) for the first time since
1958.
The last time this happened, the market saw +43.4% gains in 1958
and +12.0% gains in 1959.
--
GDO Research Staff
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U.S.
real estate investment trusts may pay more of their dividends in
2009 in stock rather than cash to save $10 billion a year.
"Seventy companies out of 100 are likely to do this," said Dean
Frankel of Urdang Securities. "It's about liquidity and concerns
over debt. Every dollar they have, the better."
REITs, a $465 billion industry, could save $10 billion this year
by paying 90% of dividends with stock, according to Bloomberg
calculations using Merrill Lynch forecasts.
--
Bloomberg
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