If a stock offers a high dividend yield, it often signal trouble at the company. The dividend yield, after all, is calculated by dividing the annual dividend by the current price -- if the price collapses due to a fundamental weakness in the company's outlook, the dividend yield is going to shoot higher.
In other words, just because a stock offers a high dividend yield doesn't mean that the company will have the resources to continue paying the dividend.
To protect you from such a scenario, we looked for dividend stocks that have significant cash flows relative to dividend per share estimates.
All of the stocks mentioned below have cash flow per share that exceeds more than 1.5 times the projected dividend per share for the current year.
We then narrowed down the list by focusing on companies with low dividend payout ratios. The dividend payout ratio, which measures the size of a dividend payment to the company's net income, can be a useful indicator of dividend quality.
Companies with low dividend payout ratios choose to retain most of their income, instead of paying it out as dividends. This income can then be reinvested into projects that will hopefully generate future growth, which will help the company increase future dividend payments.
All of the companies mentioned below have trailing 12 month dividend payout ratios below 35%.
To further refine the quality of the list, we went back in time, and identified the dividend stocks that outperformed the S&P 500 during the most recent downturn (between Oct 1, 2007-Feb 1, 2009).
Of course, past performance is no guarantee of future results. But when you consider the solid cash flows of the companies below, and their track record during market downturns, this list might offer a good starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)
List sorted by dividend yield.
1. Cal-Maine Foods
2. Tower Group
3. The Hanover Insurance Group
4. Teva Pharmaceutical Industries
5. Ross Stores
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
Kapitall's Eben Esterhuizen does not own any of the shares mentioned above.
The Motley Fool owns shares of Cal-Maine Foods and Teva Pharmaceutical Industries. Motley Fool newsletter services have recommended buying shares of Teva Pharmaceutical Industries. 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.