Cash In With These Big, Safe Dividends

There's been a renaissance in dividend investing. Could this simply be because investors have been scared silly about two nasty stock market crashes in the past decade or so? Could be. But no matter what the reason is, I love it because it brings investing back to the basics -- that is, investing in companies that actually distribute part of their profits to you rather than speculating on something way out in the unknowable future.

One of the big questions for dividend investors is whether they should target big dividend yields or companies that reliably grow their dividends. I include both in my personal portfolio, but I've argued that high yielders may actually have an edge when it comes to total returns. So it doesn't seem far-fetched at all to expect a high-yield portfolio to beat the market.

But there's a catch
Not all dividends are built the same, especially when it comes to the higher-yield group, and some could be at risk of getting slashed.

For that reason, I wanted to try and track down stocks with high yields whose payouts were safer than average. This isn't an exact science. Due to one-time items in companies' results, a payout can look safer than it actually is. Take Ares Capital (Nasdaq: ARCC  ) , for instance. It yields 8.2% right now, and a simple calculation of its payout ratio shows a result of 32.8%. But most of the company's "income" in the 12 months ending in September was below the operating line. Without those big gains, the company's payout ratio is much higher.

I also wanted to avoid companies with short operating histories. Mortgage REIT American Capital Agency (Nasdaq: AGNC  ) has a whopping 19.3% yield, and its payout ratio of 71% is very reasonable. However, the company has only been in existence since 2008. While I'm not much of a fan of mortgage REITs in general, I'd pick competitor Annaly Capital over American Capital simply because the longer operating history gives us some sense of how management is able to navigate the business cycles. That said, Annaly won't make the list either because its payout ratio is much higher.

Finally, I didn't simply want to find companies with low payout ratios. Instead, I wanted to try and strike a balance between dividend yield, payout ratio, business quality, and, where possible, dividend growth.

The picks
To even be considered for this list, a stock had to have a yield of at least 5%. And because most high-yielders get their hefty yields by paying out most of their income, requiring a payout ratio below 80% cuts the number of opportunities substantially.

And yes, I do realize that the payout ratio requirement will eliminate most REITs and other companies required to pay out all or nearly all of their income. But the point here is to look for dividend payers that potentially have some cushion against cuts.

Company

Dividend Yield

Payout Ratio

5-Year Dividend Growth

Telefonica (NYSE: TEF  ) 7.1% 52% 37%
National Grid (NYSE: NGG  ) 6.7% 72% 8%
AT&T (NYSE: T  ) 6.1% 50% 5%
Eli Lilly (NYSE: LLY  ) 5.5% 43% 5%
Total (NYSE: TOT  ) 5.2% 48% 7%

Sources: Capital IQ, a Standard & Poor's company; company websites; and author's calculations.

Here's an added bonus: Over each of the past five years, every one of these companies logged earnings per share (excluding one-time charges) that were above the current dividend.

Certainly none of this gives us any guarantee about these companies' dividends. However, it does provide a good amount of comfort that the dividends will continue at the current level and may even grow.

Of course, Mr. Market is offering the hefty dividends on these stocks because he's concerned about them. Whether it's the European crisis weighing on Telefonica, competition from Verizon and other carriers in the U.S. for AT&T, and patent expirations for Eli Lilly, investors are worried that these companies could face some serious headwinds in the years ahead.

But in each of these cases, I think pessimists have gone too far and given investors the opportunity to grab sizeable dividend that have some cushion against bumps in the road. I currently own AT&T, Eli Lilly, and Total in my personal portfolio, and all of these stocks are outperform picks in my CAPS portfolio.

Hungry for even more quality dividend picks? My fellow Fools have put together a special report listing 13 high-yielding dividend stocks that they think should be on your "buy" list. You can check out a free copy of this report.

National Grid and Total SA are Motley Fool Income Investor picks. The Fool owns shares of Annaly Capital Management, and Telefonica. 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.

Fool contributor Matt Koppenheffer owns shares of Total, Eli Lilly, and AT&T, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (11) | Recommend This Article (63)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 17, 2011, at 5:14 PM, notgilstratton wrote:

    Re: AGNC. You are concerned because this company is only 2 plus years old. Have you considered that it is a subsidiary of American Capital Ltd.? A firm which has been around for considerably longer. They would appear to know what they're doing. Perhaps you should rethink your position on this one. Yes, I do own a position in AGNC which has lived up to expectations. And yes, I will sell my shares when interest rates move upward across the board. I don't wish to get caught in the squeeze.

  • Report this Comment On February 17, 2011, at 8:23 PM, NovaB wrote:

    I've owned Annaly about 10 years. Bought 200 shares and haven't added a penny. I know have 419 shares.

    Bought Gramercy at 2.20 in December. It closed at 5.30 today (and yesterday).

    So far I am happy with the REITs I own. They are performing better than Pfizer or ConAgra at the moment.

  • Report this Comment On February 17, 2011, at 9:14 PM, lowmaple wrote:

    NovaB

    It is great for those who have owned annaly for years since even if prices go down they will have capital gains as well as all the payouts, but anyone buying now could lose some capital if a sudden rise in interests rare occurs

  • Report this Comment On February 18, 2011, at 9:39 AM, stoxmri wrote:

    The author is focusing on exactly the right theme, large, sustainable dividends but he is missing 3 huge points about ARES:

    1) they don't pay taxes so he has to adjust the payout ratio's he's calculated for the total of dividends plus taxes because both have to be removed from income. He ignores this.

    2) A BDC is supposed to be a portfolio company who does cash flow lending ONLY to companies who are already cash flow positive and are doing deals. Thank God banks are too stupid to know how to do this and stick to their Industrial Age asset based lending formula's. (Can anyone spell Dinosaur?) Therefore like any portfolio manager, Ares buys when the value is right and sells when the values are stretched, so capital gains or losses are a NATURAL PART of their income. BDC's cannot be analyzed identically to standard operating companies! Hello!

    3) A BDC is a leveraged play on the economy. So at times like this when we are closer to the beginning of the up cycle, the prospect for accelerating loan volumes and deal activity means the next 4 Q's for ARES should be above trend and beat estimates.

    So let me get this straight; I own a company who will show accelerating earnings, will beat estimates, will announce accelerating deal activity and I'm starting with more than double the market yield and 10 yr treasury yield!!!

    How do you spell "slam dunk"??

  • Report this Comment On February 18, 2011, at 9:46 AM, mikecart1 wrote:

    lowmaple,

    Interest rates don't rise overnight or instantly. It is the same way with people using the excuse to not lift weights to get fit with sayings like "i don't want to build so much muscle and look huge". They don't and you won't. Own NLY and let it take your portfolio places you never seen before, experience investing like you've never experienced before!

  • Report this Comment On February 18, 2011, at 10:28 AM, OrionNebula wrote:

    Own them all, and some stronger recent dividend growers like WAG, TGT, and WMT, all of which I believe have 10-year divy growth rates over ten, or much higher.

  • Report this Comment On February 19, 2011, at 5:23 PM, sagolfer wrote:

    Stock prices reflect what investors think will happen to a stock (or dividend) in the future. It is true that interest rates don't usually rise overnight however just the hint of rising rates will scare investors. REIT stock prices may drop fast. Faster than you can sell without losing a good chunk. Just look a muni funds now with just the hint of defaults.

  • Report this Comment On February 22, 2011, at 12:40 AM, TMFKopp wrote:

    @stoxmri

    #1. So what you're saying is that the payout ratio would be even higher? Yes, that's true if you want to think about it that way.

    #2. BDCs are only as good as the folks doing the investing, just like a mutual fund, PE shop, or big investment bank. It's a particular business model, yes, but being a BDC doesn't mean that a company is free from a simple law of dividends: If a company pays out more than it makes for too long the payout goes away.

    #3. It's true that they're leveraged to the economy (but really, what isn't?). The thing to look out for is how the company manages itself during the end of up cycles. If they started lending/investing like mad and are now sitting on loans to ravaged companies, it may take longer for it to rebound.

    These are general thoughts on BDCs -- I haven't analyzed Ares' portfolio closely.

    Matt

  • Report this Comment On February 25, 2011, at 4:06 PM, djartek wrote:

    My only issue with Ares is their ability to produce consistent Free Cash Flow. The last 5 year average is at -104Million, and 2010 is at -220Million. If they can continue paying out dividends with out their market cap falling, then I would see it as a pure dividend play and nothing more.

  • Report this Comment On February 26, 2011, at 10:06 AM, azinvstr wrote:

    Where did you get your data from? According to Friday's close, the yield on NGG was less than 5%:

    Div & Yield: 2.05 (4.50%)

  • Report this Comment On February 28, 2011, at 7:51 AM, GW1000 wrote:

    Djartek:

    The NGG yield quote by Matt was correct. Check the dividend history. The initial dividend payment is much less than the second dividend payment. The indicated dividend yield less than 5% was incorrectly obtained by multiplying the initial dividend payment by two.

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