5 Dividend Stocks to Buy, 5 to Avoid

There is no dividend bubble.

Or, at least, that's what I concluded last week when I dug into the numbers for dividend stocks to see if they've truly been bid up beyond reason by yield-hungry investors.

In short, I found that on average dividend stocks in the S&P 500 currently have a higher yield, a lower valuation, and a lower payout ratio than they've had over the past 10 years. Of course, for investors wanting to invest in individual dividend stocks, "on average" may mean that the picking is a bit easier, but it doesn't guarantee that you'll grab a dividend stock on the right side of that average.

In fact, as I pointed out in my previous article, some traditional dividend powerhouses like Consolidated Edison don't look particularly attractive when compared to their historical numbers. So today, I thought I'd share a closer look at some of the individual stocks whose numbers make them look like good buys, and a few like Con Ed that may need to cool off a bit.

Five to buy

Company

Dividend Yield

Enterprise Value / Operating Income

Payout Ratio

Exelon (NYSE: EXC  ) 5.4% 8.5 55.8%
Eli Lilly (NYSE: LLY  ) 5.0% 7.2 50.1%
General Electric (NYSE: GE  ) 3.5% 33.0 45.6%
Intel (Nasdaq: INTC  ) 3.1% 7.3 31.9%
Eaton 2.9% 12.4 34.2%

Source: S&P Capital IQ.

Now let's be clear as to why these stocks made the list. In each case, the dividend yield was higher, the valuation multiple was lower, and the payout ratio was lower than the average over the past 10 years. So, for example, though Eaton's 2.9% dividend yield may seem low for the group, its average dividend yield over the past decade was just 2.4%. And while GE's valuation multiple may seem high, the average over the past 10 years was a slightly higher 33.6 (note that enterprise value includes debt, and GE's financial arm carries a good deal of debt).

There are no guarantees when it comes to investing, and this group is no exception. The market may be purposely allowing valuations to fall and yields to rise precisely because investors know that the future may not be as bright for some of these companies as the past has been. Lilly, for instance, is among the major pharma companies that faces a wave of patent expirations. Intel, meanwhile, is trying to deal with the fact that its chips aren't the de facto standard in the fast-growing mobile world.

That said, I like risk/reward trade-off for these stocks enough that I've rated them all outperformers in my Motley Fool CAPS portfolio (there's nothing like accountability!). I've also purchased Intel and Lilly in my personal portfolio.

And then there're these guys...

Company

Dividend Yield

Enterprise Value / Operating Income

Payout Ratio

Southern Company (NYSE: SO  ) 4.3% 14.0 72.7%
ONEOK 3.0% 12.3 63.0%
Plum Creek Timber 4.3% 26.8 140.9%
Kimco Realty 4.1% 28.5 267.4%
Ventas 4.4% 41.0 143.0%

Source: S&P Capital IQ.

As with the companies above, the spots on this list were earned by the numbers. In this case though, I've included stocks with a lower dividend yield, higher valuation, and higher payout ratio than they've had in the past. So while Plum Creek, Kimco, and Ventas all typically have very high payout ratios, in each case the current ratio is unusually high. And though ONEOK's multiple may look low compared to the rest of the group, historically investors have been able to buy it at an even lower valuation.

To be sure, being on this list doesn't mean that these are terrible companies by any stretch. Included on the list are a few Motley Fool newsletter picks -- Southern, ONEOK, and Plum Creek -- and if I happened to own one of these I may not be rushing to sell. However, despite the fact that there is no broad dividend bubble, these stocks all look a bit bloated and don't appear to be great buying opportunities today.

The bottom line
The conclusion boils down pretty simply. First, investors are right to be excited about dividends: Not only have they been shown as a key contributor to investing success, but dividend stocks broadly look prime for the picking right now. However, investors buying individual dividend stocks still need to be sure to do their homework, because while many dividend stocks look like good buys, not all of them do.

If the five buy ideas above weren't enough for you, my fellow Fools have gathered together 11 more dividend ideas in a special report: "Secure Your Future With 11 Rock-Solid Dividend Stocks." You can get a free copy of that report by clicking here.

The Motley Fool owns shares of Plum Creek Timber and Intel. The Fool owns shares of and has created a covered strangle position in Plum Creek Timber. Motley Fool newsletter services have recommended buying shares of Southern, Exelon, Intel, and ONEOK. Motley Fool newsletter services have also recommended creating a write covered strangle position in Exelon. 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 Eli Lilly and Intel, but does not have a financial interest in any of the 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 Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (24) | Recommend This Article (85)

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 March 02, 2012, at 4:46 PM, smallcomp84 wrote:

    What would your recommendation be if you've held ONEOK for 3+ years?

  • Report this Comment On March 02, 2012, at 5:40 PM, jm7700229 wrote:

    Similar question to the above: I am holding SO -- is it now overvalued? Doesn't seem so with that yield and payout ration, but maybe I should take my gains?

  • Report this Comment On March 02, 2012, at 5:55 PM, Bsorge10 wrote:

    Oneok is an MLP which plays by different rules. MLP's are partially a return of capital so the payout ratio is less meaningful. This should be pointed out and cash flow is the important factor.

  • Report this Comment On March 02, 2012, at 6:28 PM, TMFKopp wrote:

    @smallcomp84 and jm7700229

    Hey folks, first, thanks for reading!

    Everyone's situation is a bit different and I'm not an investment advisor, so I'm not in a position to tell you what do to in your portfolios.

    But here's what I will say. For my own personal portfolio, the majority of the analysis that I do on stocks I'm going to buy falls into two areas: the business and the valuation. Except in select cases, if either falls short, I won't buy the stock. There are thousands of stocks out there, so my preference is to stick to buying in situations where I like the business and the valuation.

    That said, once I've bought a stock, I'm in no rush to be a seller. Since I've (hopefully!) bought a good business, I'm not keen to dump that business unless something happens that makes the business less attractive. And though the *current* valuation may not be as attractive, since I (hopefully!) bought at an attractive valuation, I'm not in a rush to jump in and out -- valuation only starts to be a reason for me to sell when a stock gets considerably overvalued.

    As an example, I currently own Chevron shares. When I bought, I really liked the valuation. Today, I don't think the valuation is quite as attractive. As a result, I'm not rushing out to add to my Chevron shares, but I'm hanging on to the ones I own.

    So if I were you and, say, holding Southern Co., I would take some time to figure out what I thought the shares were worth (it's possible you may not think they're overvalued in the first place!). I'd then base my buy/sell/hold decision based on the extent to which they're overvalued (again, if they are at all), the faith I have in the company (I'm more willing to hold a great company at a high price than a good company at a high price), and the other opportunities that I have available.

    And of course tax considerations and trading costs should also play a factor in the decision.

    Hope that helps!

    Matt

  • Report this Comment On March 02, 2012, at 6:32 PM, LSLOANPDX wrote:

    Ten stocks and only five with tickers.

    Is it true that Eaton, Oneok, Plum Creek, Kimko and Ventas don' have tickers or is this just poor, writing and proofing.

    I/we pay for complete information and 50% tickers missing is not what I/we pay for.

  • Report this Comment On March 02, 2012, at 6:56 PM, durango58 wrote:

    I've had OKS, PCL, INTL and SO for a number of years. Their yields on MY money invested are roughly double what you see here. In other words, I have nice Cap Gains along with a nice yield on the amount invested. I see no reason to dump them as of now.

  • Report this Comment On March 02, 2012, at 6:58 PM, durango58 wrote:

    Wrong symbol; I meant INTC.

  • Report this Comment On March 02, 2012, at 9:21 PM, kanawha40 wrote:

    @LSLOANPDX - OMG - you mean to tell me that you have to have everything spoon fed to you! How do you do any research or due diligence on stocks without knowing how to look up a ticker? You need to go and just buy some mutual fund and call it a day. Some folks would complain if you hung them with a new rope!

  • Report this Comment On March 02, 2012, at 9:25 PM, greyone99 wrote:

    AT&T would also be a good dividend pick up stock.

  • Report this Comment On March 02, 2012, at 9:51 PM, MIAfool100 wrote:

    why aren't you in favor of NLY with a dividend of over 13%??

  • Report this Comment On March 03, 2012, at 1:22 AM, jdwelch62 wrote:

    I've been following your series of articles, Matt. As a relatively new investor who is focusing on worthy dividend stocks, I appreciate what you've provided us with so far. Please keep 'em coming...

    Fool on!... :-)

  • Report this Comment On March 03, 2012, at 2:48 PM, mohamedziauddin wrote:

    Those stocks whose payout ratios over 100%---

    means that their dividends exceed their income.

    How safe are their dividends in the long run?

  • Report this Comment On March 03, 2012, at 4:58 PM, bigsur2 wrote:

    matt,

    what is your opinion of FE? using the 3 parameters you describe? do you give any positive points for it being on the DJUI as is your choice EXC?

  • Report this Comment On March 03, 2012, at 7:41 PM, TMFKopp wrote:

    @MIAfool100

    "why aren't you in favor of NLY with a dividend of over 13%??"

    I'm not a fan of the business model. Further, I think the current yield reflects the potential for capital loss if rates move against the company.

    @jdwelch62

    Thanks!

    @mohamedziauddin

    "Those stocks whose payout ratios over 100%---means that their dividends exceed their income. How safe are their dividends in the long run?"

    One thing that's important to recognize is that for some companies, there are other measures that are better for judging the long-term viability of their dividend. Kimco, for example, is a shopping-center REIT and the safety of its dividend is better judged against a measure of cash flow rather than earnings. In many cases, REITs and other asset-play companies refer to a measure called "funds from operations" and that's a better number to use for dividend safety.

    The reason I used payout ratio is to keep it consistent throughout. I was looking for the delta across that measure, rather than using that measure as a measure of dividend safety.

    @bigsur2

    "what is your opinion of FE? using the 3 parameters you describe? do you give any positive points for it being on the DJUI as is your choice EXC?"

    I actually don't have an opinion on FE off the top of my head and the data for this article is on a different computer. On Monday I'll try to look back and see how it fares with the data.

    To your other question, inclusion in certain indexes doesn't really play a role in my investing process. Most of the time, inclusion in an index is more a function of size than quality or value.

    Matt

  • Report this Comment On March 03, 2012, at 7:47 PM, spielermann wrote:

    payout ratio is a too simplistic measure, and cannot be applied universally to all companies. Net Income, if that is what you want to look at, you miss a lot of the true picture. Accounting profits, or GAAP, is nothing I really care about, when it does not represent, or closely follow the cash flows of the business. Would you rather have accounting profits, or economic profits? So, payout ratios over 100%, may or may not be a problem.- what is going on with the firms cash flows.

  • Report this Comment On March 03, 2012, at 8:22 PM, 5thand7th wrote:

    LSOANPDX, are you helpless?

  • Report this Comment On March 04, 2012, at 11:58 AM, NHiggins94 wrote:

    Hi

    I live in NW Montana in the center of whats basically Plum Creek territory, they have a huge mill in our town and smaller ones all over, half the dirt roads belong to them etc. And I was wondering if you could elaborate further on why they're a poor pick? They're one of (if not THE) largest land holder in the U.S. They've maintained a steady dividend for years and the only reason the payout ratio is so high is because we're in the middle of a housing depression (i.e. nobody buys lumber). I recently talked with a V.P. from the company and she said that for me to buy stock would be an extremely wise decision as she feels the company is financially secure for decades to come and as a high-school student I'm a long term investor and am seriously considering starting with them.

    Thanks very much for the article!

  • Report this Comment On March 05, 2012, at 11:13 AM, my1bird wrote:

    Via the fools advice, with current conditions earlier this am. I picked up a a position of EXC and I'm sure it was a prudent choice to replace my former position in CCL and the current enviorment we are in.

  • Report this Comment On March 05, 2012, at 4:55 PM, TMFKopp wrote:

    @bigsur2

    As promised...

    FirstEnergy's current yield is above its historical yield. However, its valuation and payout ratio are both above historical averages.

    Matt

  • Report this Comment On March 05, 2012, at 5:07 PM, TMFKopp wrote:

    @NHiggins94

    First, and most importantly:

    "as a high-school student I'm a long term investor"

    KUDOS to you for being a high school student and learning about investing. The earlier you start, the more you can learn, the more experience you can gather, and, maybe most importantly, the more opportunity you have to make lots of mistakes before you have a lot of money to lose (or maybe that was just my experience...).

    As far as Plum Creek in particular, let me reiterate that the fact that it's included above does not mean that I think it's a terrible company -- in fact, pretty much all of the companies above are pretty darn good companies.

    What I'm more concerned about with the five that I put on the "avoid" list is that the wave of investors chasing yield has pushed up the valuation of those stocks beyond historical levels. If it turns out that I'm correct, those buying the stock today probably won't get the kind of total return that they're hoping for.

    Of course there's also the possibility that I'm wrong and that as the industry and economy turns back around it will be clear that today's price is actually a bargain.

    If that sounds unhelpful, here's the bottom line: Take this as an opportunity to form your own conclusion. Consider the three factors that I've laid out above in conjunction with the other information that you've found. As an investor, one thing you'll have to learn is how to put all the pieces together and weigh both positive and negative views that you read -- no matter what, you'll *always* be able to find someone talking down a stock that you like or talking up one that you hate.

    I hope this helps, good luck, keep it up, and Fool on!

    Matt

  • Report this Comment On March 08, 2012, at 9:02 PM, midwestbonsai wrote:

    Boy, I must be doing something right. I already have 2 of the 5 to buy and none of the 5 to avoid. Thanks!

  • Report this Comment On March 10, 2012, at 7:39 PM, aleax wrote:

    I own INTC for the long term and love their business prospects -- the dividend is just a welcome sweetener and mostly I'll keep holding as I see them still hovering substantially below fair value as I evaluate it (I'd hold even at fair value or a bit above because of my appreciation for the company's quality and prospects).

    I used to hold SO too for a long time -- but I keep re-running valuation checks (because a TMF service I follow has it on hold on valuation issues) and finally I have to agree with them (though I still think their fair value assessment is too low, the price is well above even the higher fair value as I measure it). I don't do "hold" for stocks *seriously* above fair value, so, I sold.

    PCL, another long time holding, is still well within its fair valuation as I measure it -- the latter in this case is mostly based on their incredible asset endowment. Yeah, they have large debts too, but if any firm can afford to leverage at today's excellent rate, it's one whose assets, if under-exploited, far from depreciating, keep growing and increasing -- as wood-producing trees do!-)

  • Report this Comment On March 11, 2012, at 10:43 PM, irwann wrote:

    I'm an amateur but interested in dividend stocks. Could someone tell me if there's an easy way to find the historical dividend yield for individual stocks? Thanks, Irwin

  • Report this Comment On March 12, 2012, at 5:58 AM, FoolishMikee wrote:

    As TMFKopp pointed out, most of these companies are pretty good businesses, as far as valuation is involved, a metric to counter the overvaluation for Kimco Realty is its FFO (funds from operations) payout ratio for MRQ of ($0.19*4)/$1.27 giving a payout ratio of 60%, inidcating that the dividend might be more sustainable than perceived by the payout ratio.

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