The Big Dividend Report

Welcome to the first issue of The Big Dividend Report!

In this low-interest-rate, high-volatility market, many investors are looking to dividend stocks to provide regular income streams. Not surprisingly, the stocks with the highest dividend yields are getting outsized attention.

Bigger doesn't always mean better, though. If a dividend isn't sustainable, a company's stock faces the double whammy of a reduced dividend and a falling stock price. Oftentimes, a big dividend yield is a siren song.

In this recurring article series, my aim is to check under the hood of the biggest dividends in the market and to keep you updated on the latest and greatest. We will limit ourselves to the biggest 20 dividends coming from companies with at least $2 billion in market cap.

Here are the current high yielders along with their respective sectors and payout ratios (the percentage of net income that gets paid out in dividends).

Source: Yahoo! Finance and Capital IQ, a division of Standard & Poor's.

Many of these high yielders are from the same sectors:

• Real-estate investment trusts -- The top five yielders are mortgage REITs. These are REITs that buy mortgage-backed securities rather than physical real estate (lower on the list, Hospitality Properties Trust does this). REITs are required to pay out at least 90% of their taxable income in order to qualify for advantaged tax treatment. That's why dividends tend to be high and why payout ratios aren't very helpful. With the low short-term interest rate environment, they've been able to borrow cheaply and earn large spreads on their longer-duration assets. With the Federal Reserve promising to hold short-term interest rates in check through at least 2013, mortgage REITs' spreads look to be in good shape in the near term. However, since they tend to be highly leveraged and rely on the repo market (read: short-term borrowing), there are still dangers lurking. This is a sector that requires trust in management. Unfortunately, most REITs don't have much of a track record. Annaly , founded in 1996, is considered a pioneer.
• Master limited partnerships and royalty trusts -- These structures are common in the energy sector and like REITs pay out dividends by rule in exchange for tax-advantaged status. Many MLPs are pipeline or storage companies, whose toll-like business structures are conducive to steady dividends. Royalty trusts can allow investors to invest directly in the output of oil or natural gas assets.  
• Telecommunications -- Many of the biggest dividend yields are from telecom companies. You'll notice some payout ratios well over 100% (which implies unsustainability), but you should also check their cash flows before writing them off. For example, Frontier doesn't come close to covering its dividends with net income, but does with free cash flow. This is largely due to capital expenditures lagging depreciation. On the other end of the scale, note that Portugal Telecom's 10% payout ratio isn't as good as advertised because most of its earnings are due to discontinued operations.

This ends our first issue of The Big Dividend Report. We've looked at the big players and have taken a spin through the most fundamental metric to check for dividend health -- payout ratio. This gives us a good start.

To keep track of all our analysis on any of these companies, including future issues of The Big Dividend Report, click here to add them to My Watchlist.