5 A-Rated Dividend Stocks

The dividend landscape was turned upside down during the financial crisis. During the fourth quarter of 2008 alone, 288 companies cut payouts. Not to be outdone, according to Standard & Poor's, 804 more dividend payments were cut by public companies in 2009 -- costing investors an additional $58 billion.

Fortunately, those dark days are behind us, and companies have generally been raising their payouts. According to recent S&P data, fully 444 companies raised their dividend in the second quarter, up from 335 in the second quarter of 2010.

Still, dividend cuts remain a clear and present danger as 21 companies cut their payouts in the second quarter. Among this group were Hudson City Bancorp and World Wrestling Entertainment (NYSE: WWE  ) .

It's precisely these scenarios that we want to avoid as dividend investors. When a company cuts or suspends its dividend, not only would we see a decrease in dividend income, but we'd normally see a drop in the company's share price. That's a double-whammy we want no part of.

Lessons learned
To me, the silver lining in the dividend debacle of recent years has been gaining more valuable insight into why companies feel compelled to cut or suspend their dividend payouts. If we can gain better understanding, perhaps we can avoid getting stung in the future.

It was in this spirit that I created the Dividend Report Card last year. Having researched the causes of past dividend cuts and suspensions, I created a spreadsheet that "grades" a company on a number of financial metrics that I believe will help us steer clear of dividend debacles.

For example, World Wrestling Entertainment scores an "F" on the Dividend Report Card, mainly because it was paying out more in dividends than it was generating in profits or free cash flow.

The Dividend Report Card is also a great tool for gauging the health of a company's dividend, and it can tell us a little about the company's overall health as well, but it shouldn't be seen as a buy-or-sell decision-making program.

That said, here are five companies that currently score an "A-" or better according to the Dividend Report Card:

Company

Dividend Yield

DRC Score

Lowe's (NYSE: LOW  )

2.4%

A-

ExxonMobil (NYSE: XOM  )

2.3%

A

Microsoft (Nasdaq: MSFT  )

2.4%

A+

United Technologies (NYSE: UTX  )

2.2%

A

Walgreen (NYSE: WAG  )

2.1%

A+

Source: Capital IQ, a Standard & Poor's company, as of July 19.

Three things these companies share are good dividend track records, solid balance sheets, and plenty of free cash flow coverage for their payouts.

Company

5-Year Dividend Growth Rate

Interest Coverage

Free Cash Flow Coverage

Lowe's

29.6%

10.1 times

3.4 times

ExxonMobil

8.1%

200 times

2.9 times

Microsoft

7.7%

116 times

4.1 times

United Technologies

14.1%

10.9 times

3.3 times

Walgreen

21.9%

50.6 times

4.1 times

You could do far worse than start your research with these five companies, but their sub-3% yields may not set your heart aflutter, so I'll throw in a bonus A-rated high-yield stock: Lockheed Martin (NYSE: LMT  ) .

The world's largest defense contractor yields 3.9% and is currently hampered by quite reasonable concerns about the state of the U.S. defense budget in coming years. And though it does have a sizeable pension deficit, its balance sheet is still good; Morningstar gives Lockheed a credit rating of "A+," and the company generates $11 in operating earnings for each $1 it spends on interest payments. Moreover, it produces $3.55 in free cash flow for each $1 it pays out in dividends.

Lockheed shares could be volatile as we get more clarity on the defense budget, but it's certainly one high-yield stock worth looking into.

Foolish bottom line
The financial crisis exposed many of the market's weak dividend-paying companies and provided investors with invaluable lessons for identifying both unhealthy and healthy dividends.

Focusing on key financial metrics such as the dividend track record, interest coverage ratio, and free cash flow coverage should provide us with a much better opportunity to separate the good dividends from the bad and as a result realize better long-term returns.

These five A-rated dividend stocks (plus Lockheed) are good starting points for further research. To get more ideas for great dividend-paying stocks, be sure to check out our special free report: "13 High-Yielding Stocks to Buy Today."

Todd Wenning is the advisor of Motley Fool (UK) Dividend Edge. You can follow him on Twitter. He and The Motley Fool own shares of Microsoft. Motley Fool newsletter services have recommended buying shares of Lowe's and Microsoft, a covered call strategy on Lowe's, and a diagonal call strategy on Microsoft.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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