Dividends You Can Believe In

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At the end of February, I took a look at the increasing number of companies slashing their dividends.

While many investors believed those cuts were unexpected, I wrote that that there were two key signals that investors could have noticed ahead of time:

1. A dividend yield higher than 20% (such a yield indicates that investors believe the firm's financial footing is very weak -- and they are often correct).
2. And a high free-cash-flow payout ratio (such a ratio indicates that the firm might be overextending itself by paying out dividends when it should be conserving cash).

With these two criteria in mind, I ultimately advised investors against putting new money in stocks like Allied Capital (NYSE: ALD), China Mobile (NYSE: CHL), Luxottica (NYSE: LUX), and Boston Properties (NYSE: BXP).  

The cuts keep coming
Although more than $64 billion in dividend payments was eliminated from the S&P 500 between September 2008 and March, not all dividend-paying companies are in danger of slashing their payouts.

In fact, although many companies' yields have risen due to their falling share price, that alone doesn't indicate that a dividend might be cut. The difference? Fundamentals.

A company with a stable revenue stream, a modest payout ratio, and that employs a manageable amount of leverage should be able to withstand difficult economic situations and continue rewarding dividend investors with sure gains.

The dividends to count on
To track down such stocks, I reversed my high free-cash-flow payout ratio screen from February and scanned for companies with a significant yield (more than 4%), a modest debt-to-capital ratio (less than 60%), and with a free-cash-flow payout ratio below 25% (which is a very good thing!).

Here are some of the companies I found:

Company	Market Cap	Dividend Yield	Debt-to-Capital Ratio	Free-Cash-Flow Payout Ratio
Allianz (NYSE: AZ)	$44.9 billion	4.9%	41%	2%
Innophos (Nasdaq: IPHS)	$345 million	4.4%	55%	9%
PPG Industries (NYSE: PPG)	$7.5 billion	4.6%	56%	14%

Data from Capital IQ. Free-cash-flow payout ratio calculated using levered free cash flow.

While not all of these are formal recommendations, they are good candidates for further research.

Finding the right yields
In a volatile market like this one, a high dividend yield alone is not enough to tell you whether the payout -- or even the company -- is in trouble. Again, you must look at the amount of debt the company uses and whether it might be overextending itself by paying a dividend.

The best dividend payers are those that have a robust yield backed by strong fundamentals -- and these are the kind of companies the team at Motley Fool Income Investor, led by former hedge fund analyst James Early, is looking for in the current market environment. You can see all of their top recommendations completely free. Click here for more information.

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Adam J. Wiederman owns no shares of the companies mentioned above. PPG Industries is a Motley Fool Income Investor recommendation. You can view the Fool's disclosure policy here.