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The Safest Dividend in the Dow |
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--
Carla Pasternak |
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The 30 stocks in the Dow Jones Industrial
Average 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 (NYSE: GE)
double-digit dividend yield looked pretty juicy a few months ago --
that is, until they slashed it by -68%. And Citigroup (NYSE: 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.
(Full Story Below) |
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The Safest Dividend in the Dow
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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 Dow
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Company Name |
Current Yield |
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Kraft Foods (NYSE: KFT) |
4.4% |
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Caterpillar (NYSE: CAT) |
4.4% |
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Pfizer (NYSE: PFE) |
4.5% |
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Merck (NYSE: MRK) |
5.9% |
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DuPont (NYSE: DD) |
6.1% |
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Verizon (NYSE: VZ) |
6.3% |
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AT&T (NYSE: T) |
6.8% |
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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.
|
Company |
2008 EPS |
'09
Est. EPS |
Change |
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Kraft Foods |
$1.18 |
$1.91 |
+62.0% |
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Caterpillar |
$5.66 |
$1.18 |
-79.1% |
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Pfizer |
$2.42 |
$1.95 |
-19.4% |
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Merck |
$3.42 |
$3.22 |
-6.0% |
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DuPont |
$2.78 |
$1.75 |
-37.1% |
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Verizon |
$2.54 |
$2.54 |
0% |
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AT&T |
$2.81 |
$2.08 |
-26.1% |
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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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Discount
to Avg. P/E |
Dividend
Growth Rate |
Avg. Annual Total Returns |
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Kraft Foods |
-27.1% |
+10.6% |
+0.5% |
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Verizon |
-27.1% |
+3.3% |
+2.2% |
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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 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.
-- Carla Pasternak
Editor, Carla Pasternak's Dividend Opportunities
P.S.
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Notes
For the first time since October, high-yield debt is pricing at
a 9.99 percentage-point premium over Treasurys -- hair below the
distressed benchmark of 10 percentage points, according to S&P.
Spreads peaked at a whopping 17.54 percentage points in
December, according to S&P data. Their recalibration this year
has been led by high returns in the retail and auto sectors -- ones
that had been hardest hit in 2008.
--
Wall Street Journal
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