The Dow's Best 2 Dividends

I'm a sucker for big dividends, so when I saw these two monster dividend yields, I had to share them with all of you. Let's put them to the test to see whether they truly deserve your investment.

Welcome to the major leagues
The world knows AT&T (NYSE: T  ) and Verizon (NYSE: VZ  ) as America's largest telecommunications providers. Investors know them as the biggest dividend payers on the Dow (INDEX: ^DJI), with yields of 6.12% and 5.61%, respectively.

To fully appreciate the significance of these yields, let's compare them to other income-producing investments.

Source: Yahoo! Finance, Bankrate.com, and Wall Street Journal. As of midday Sept. 2.

Needless to say, AT&T and Verizon's yields trounce the alternatives!

How could this be so?
AT&T and Verizon are cash cows. They each pull in more than $100 billion in revenue a year. And if you add depreciation back in and subtract out capital expenditures, they had free cash flows of $14.6 billion and $16.9 billion respectively in 2010.

Are the dividends sustainable?
To determine this, we look at the payout ratio, which divides a company's dividends per share by its earnings per share. We generally want a number between 40% and 60%, which allows the company to pay shareholders a healthy portion of the profits while still plowing plenty of cash back into the company for future growth.

For capital-intensive companies like AT&T and Verizon, however, the payout ratio can be misleading, because so much of their earnings are offset by depreciation -- a noncash expense. To account for this, I prefer to compare these companies' dividend payouts to their free cash flows.

Company

Payout Ratio

Dividends to Free Cash Flow

AT&T 50% 64%
Verizon 102% 32%

Source: Yahoo! Finance and RobotDough.com.

The ratio you use makes a big difference! Why the big disparity? Relative to its net income, Verizon deducts more in depreciation than AT&T does. When you add depreciation back in to calculate cash flow, Verizon's dividends suddenly look far cheaper.

Can the payouts be raised?
Assuming a company can raise its dividend payout, the best way to ascertain if a company will do so in the future is to look at its past. And as the following chart indicates, AT&T and Verizon both have long histories of dividend hikes.

Source: Yahoo! Finance. Dividend is per share, adjusted for splits.

They pass the test!
It's clear to me that if you're looking for dividend stocks, AT&T and Verizon both deserve your attention. Because monster dividend yields like these don't come along every day, add AT&T and Verizon to your watchlist and pounce on them when the price is right.

If you're looking for more dividend stock recommendations, check out our free report, "13 High-Yielding Stocks to Buy Today."

Fool contributor John Maxfield is considering opening a position in AT&T when permitted to do so under The Fool's disclosure policy. Motley Fool newsletter services have recommended buying shares of AT&T. 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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