We all know the story of the tortoise and the hare. In the investing world, our hares are represented by Rule Breakers-type stocks, and our turtles are ... dividend stocks. Though being a hare is much sexier, study after study has shown it's plenty wise to be a tortoise.
If anyone had a doubt about the power of dividends, they need only read Jeremy Siegel's The Future for Investors, where he writes: "Dividends matter a lot. Reinvesting dividends is the critical factor giving the edge to most winning stocks in the long run."
An important metric for dividends
The consumer goods sector has several stocks that pay huge dividends. Today I'm going to introduce you to two of the highest-paying ones that are worth your consideration -- and five that should be thrown out with the trash.
One of the most popular metrics for evaluating a dividend's health is the earnings payout ratio, which essentially measures the amount of earnings a company dedicates to paying out dividends. As the theory goes, the lower the payout ratio is, the more sustainable the dividend is.
The following table includes seven popular consumer goods stocks, listed by the size of their dividend yield, and including their payout ratio.
Source: Yahoo! Finance, dividendinvestor.com.
In their book Million Dollar Portfolio, David and Tom Gardner suggest that you should hold only stocks with a payout ratio of less than 65%. The largest dividends don't always make for the most sustainable ones.
This benchmark would make the cautious Fool worry about the sustainability of dividends from the likes of tobacco producers Vector Group and Altria, as well as Pitney Bowes and AMBEV.
But wait -- there's more!
I told you there'd only be two stocks worth looking at, and we still have three that haven't been eliminated.
This is where things get tricky. Because earnings are reported using the accrual method, companies may not yet have collected all of the money that they say they've earned. Things like accounts receivable and payable, depreciation, and goodwill are included in earnings -- and they don't immediately affect the amount of money a company has in the bank.
The good news is that there is a way to see how much money a company has put in the bank: free cash flow. This number is very important -- some Fools would say more important -- in evaluating a company's dividend sustainability. Ultimately, dividends are paid from free cash flow, not from earnings.
Check out the free cash flow payout ratio for these companies, and the story clears up a bit. For this metric, I figured out what percentage of a company's free cash flow was used to pay their dividends for the last fiscal year.
FCF Payout Ratio
Wow! That really changes things for Universal Corp. Turns out that it's had noncash charges and an increase in working capital that added up to about $155 million last year. These numbers may not have shown up on the income statement, but they definitely affected how much money the company had on hand.
As promised, this leaves us with Kimberly-Clark and Cal-Maine Foods as the two consumer goods companies worth looking into for your dividend portfolio.
If you're looking for some dividend ideas, consider some names from a free report from The Motley Fool's expert analysts called "13 High-Yielding Stocks to Buy Today," including one that a senior retail analyst calls "the dividend play of a lifetime." Tens of thousands have requested access to this report, and today I invite you to download it at no cost to you. Get instant access to the names of these 13 high yielders. It's free!
Fool contributor Brian Stoffel does not own shares of any of the companies mentioned. The Motley Fool owns shares of Altria Group and Cal-Maine Foods. Motley Fool newsletter services have recommended buying shares of Kimberly-Clark. 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.