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.
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.
5-Year Dividend Growth
|Telefonica (NYSE: TEF )
|National Grid (NYSE: NGG )
|AT&T (NYSE: T )
|Eli Lilly (NYSE: LLY )
|Total (NYSE: TOT )
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.