These Dividends Are Safe

It's beginning to feel like there are two kinds of dividend stocks out there: those that have cut their dividends and those that are about to.

And who can blame them?

In a credit crisis, companies with large dividend yields are quickly reminded that they are giving away their most readily available form of capital. And when companies' shares are priced as if they won't survive the credit crisis, shareholders sometimes see the dividend cuts as positive developments. After all, wouldn't you rather own shares in a viable company that pays no dividend than in a bankrupt company that declares high dividends all the way down into oblivion?

As a result, we're on pace for the worst dividend cuts since the 1930s, and earlier this year the stock prices of some companies like Wells Fargo, CBS, and General Electric (NYSE:GE) actually rose immediately after the news of dividend cuts.

That's all well and good, but what if, like me, you're old-fashioned and want to find some companies that can actually sustain their dividends?

Here's how to find them
We need to identify companies that:

• Still have earnings.
• Are paying less than 50% of those earnings as dividends (through the payout ratio).
• Cover their interest payments many times over with earnings before interest and taxes.

Here are a few that meet those criteria:

Source: Capital IQ, a division of Standard & Poor's. *Chevron's interest coverage ratio is not meaningful because its interest expense is virtually zero.

You'll notice this list doesn't include any eye-popping double-digit yields. Frequently, those sexier yields come from companies that are paying out more of their earnings than they can afford. Or they are leveraged up with debt and laboring under onerous interest payments. While such companies may be tempting, they are often ticking dividend time bombs.

So while the dividend yields in the table above aren't in the double digits, all are at least in the neighborhood of 10-year Treasury yields (currently 3.9%). Stocks that yield like bonds can be a beautiful, beautiful thing. Not only do you get the current yield, but you also stand to profit from any dividend increases down the road, as well as capital appreciation from currently depressed share prices.

Meanwhile, these companies are easily covering their dividend payments with earnings and aren't straining under ridiculous leverage. This doesn't mean it's impossible these companies will cut their dividends, but they're excellent candidates for further research.

In fact, our dividend experts over at our Income Investor newsletter team have already done their research. They've identified six stocks they believe should lay the foundation for a dividend-rich portfolio. I invite you to see them by taking a free 30-day trial to the service.

Click here to get started. There's no obligation to subscribe.

This article was first published April 9, 2009. It has been updated.

Anand Chokkavelu does not own shares of any companies mentioned. Procter & Gamble is a Motley Fool Income Investor recommendation. The Fool owns shares of Procter & Gamble. The Fool has a disclosure policy.