Best Dividend Play: Altria, ADP, or Annaly Capital?

In this Motley Fool series, we rank three related stocks on five criteria to determine the best buy.

Today's matchup is a battle between three stocks investors love for their dividends: Altria (NYSE: MO), Automatic Data Processing (Nasdaq: ADP), and Annaly Capital Management (NYSE: NLY).

• Altria, the tobacco company behind the Marlboro brand (Altria in the U.S., Philip Morris International (NYSE: PM) outside the U.S.), sports a 6.6% dividend yield. It has been a decades-long winner that has been underestimated because of its litigation risk. Some consider it the best of the best dividend stocks.
• ADP, the big kahuna of payroll processors, only offers a 3.3% dividend yield -- nice, but puny compared to Altria and Annaly Capital. But it has an ace in the hole. It's one of only a handful of companies rated AAA by the major ratings agencies. These are the strongest of the strong -- a very good thing for a dividend payer.
• Annaly Capital is a real estate investment trust that makes its money trading agency-backed mortgage bonds using cheap debt financing -- it pockets the spread between what it buys and what it borrows. Through a subsidiary, it also acts as the external manager of the publicly traded REITs Crexus (NYSE: CXS) and Chimera (NYSE: CIM). If Annaly's business model interests you, the others are also worth looking into. However, Annaly's bread and butter are its trading activities, which have helped Annaly post a mind-blowing 15.5% trailing dividend yield. If you want more info and analysis on Annaly before we proceed, click here.

The biggest dividend yield does not the best dividend play make. No, we care about the sustainability of that dividend and the prospects of the company as a whole. Using five short-of-scientific-but-carefully-chosen criteria, let's determine which of these dividend plays is the best buy.

Round 1: Balance sheet
It's not surprising that the AAA-rated company comes on top here. ADP sits safely atop $2 billion of net cash. Altria takes a different path. Because of its steady cash flow, it has levered itself up to the point where debt makes up 74% of its capital. It covers its interest payments easily, but it pays out well over half of its free cash flow as dividends (a dividend red flag for all but the most stable companies). Because of its business model of investing with debt proceeds, Annaly is the most levered at 85% of capital in debt. In addition, its borrowings on the repurchase market, longer term or not, are more precarious than traditional debt agreements.  Rank: (1) ADP, (2) Altria, and (3) Annaly.

Round 2: Operations
The operations at all three of these companies are impressive. Altria's brand-name dominance allows it to price well enough to generate 20% net margins (if you're wondering, Philip Morris International is up at 25%); As a REIT, Annaly pays out most of its profits ... so when it's paying dividends at a 15.5% clip, you know it's making bank; ADP, like its smaller competitor Paychex (Nasdaq: PAYX), juices profits by conservatively investing its float -- the short-term money it holds before cutting paychecks for its clients. These rankings could be argued a number of ways since they run very different, but all are very successful operations. I'm going to give all three the nod here. Rank: (1) (Tie) Annaly, Altria, and ADP.

Round 3: Safest bet
ADP doesn't have the litigation risk of Altria or the complicated business model of Annaly. It's a bit of a leap of faith trusting the balance sheets of most financial entities, and for Annaly, you have to wade in and understand the types of mortgage-backed securities being bought, the hedges in place, and the types of borrowings used. Rank: (1) ADP, (2) Altria, and (3) Annaly.

Round 4: Sexiest bet
Here's where Annaly shines. Investors dig the mega dividend. It's debatable how long the huge dividend can last. Unlike the other two, Annaly's dividend isn't tied so much to history -- it just pays out most of what it makes (to keep its favorable tax treatment). The interest rate spreads that Annaly is enjoying won't last forever, but the debate on how long they will and how masterfully Annaly can lock in these spreads via interest rate swaps oozes sex. Sorry, ADP, the only thing sexy about payroll processing is the profits. Rank: (1) Annaly, (2) Altria, and (3) ADP.

Round 5: CAPS rating
Our CAPS community members rate Altria and ADP 4 stars (out of 5). They rate Annaly a more mixed three stars, which I'd expect with polarizing stocks. Rank: (1) (Tie) Altria and ADP, and (3) Annaly.

The summary rankings

This was a very tight matchup. ADP pulled out a victory over Altria and Annaly, but each is worth a further look depending on what kind of dividend play you're looking for. All three are on my watch list (I own long-held shares of Altria and its sister company Philip Morris International already).

But what do you think? Declare your winner in the poll below and then share your thoughts in the comments section below the poll.