These Dividends Are Safe

In the past year, it's felt 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're 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 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 in decades. From Bank of America (NYSE:BAC) to Pfizer (NYSE:PFE) to Motorola, dividends have fallen like dominoes. Earlier this year, things got so bad that stock prices of companies including JPMorgan Chase, CBS, and General Electric actually rose immediately after the news of dividend cuts.

That's all well and good. But what if you're old-fashioned like me, and you want to find 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 (via the payout ratio).
• Cover their interest payments many times over with earnings before interest and taxes.

Here are a few companies that meet those criteria:

Source: Capital IQ (a division of Standard & Poor's).

You'll notice that 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 actually afford. Or they're leveraged up with debt and laboring under onerous interest payments. While such companies may be tempting, they're often ticking dividend time bombs.

So while the dividend yields in the table above aren't in the double digits, all are in the neighborhood of 10-year Treasury yields (currently 3.4%). Stocks that yield like bonds can be beautiful, beautiful things. 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 any upward stock price movements.

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

In fact, the dividend experts over at our Motley Fool Income Investor newsletter 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.

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

Anand Chokkavelu owns shares of Pfizer. Pfizer is a Motley Fool Inside Value pick. VF is a Motley Fool Income Investor selection. The Fool has a disclosure policy.