Lately, dividend yields are garnering a lot of attention as to whether they're a sign of a stock on sale, or a stock in peril. Nearly 40 members of the S&P 500 have cut their dividends since September, and the U.S. company paying the largest dividends (in dollar terms), General Electric (NYSE:GE), recently slashed its quarterly dividend to 10 cents a share from 31 cents.
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A screen of S&P 500 members turns up 12 stocks with double-digit dividend yields and with the following characteristics: share price above $10, market cap of $1 billion or larger and average daily trading volume of 1 million shares or more.
Not surprisingly, five of the names are banks and three are real estate investment trusts (REITS). Banks have been voracious dividend cutters and REITs, which are obligated to pay out 90% of their profits in the form of dividends, are diluting shareholder value by paying future dividends in the form of stock instead of cash.
Let's examine some of the names on the list for safe and unsafe dividends.
|Company||Return on Equity||Dividend Yield|
|U.S. Bancorp (NYSE:USB)||12.4%||13.5%|
|Reynolds American (NYSE:RAI)||19.5%||10.4%|
Breaking the (Shareholder's) Bank?
In the wake of recent dividend cuts by rivals JP Morgan Chase (NYSE:JPM) and PNC Financial (NYSE:PNC), the market seems to be clamoring for USB to follow suit. Warren Buffett's Berkshire Hathaway (NYSE:BRK-A, BRK-B), is USB's largest shareholder and a dividend cut by the Minnesota-based bank would make Buffett's investment in the company look even more dubious. Keep in mind that Buffett was loading up on USB shares when the stock was in the mid and high 20s, and now it languishes below $13.
In fact, a lower USB dividend appears inevitable. While the company's tier-1 capital ratio is decent at 10.6%, its tangible capital ratio of around 3.4% makes a paring of the dividend a prudent move. USB's 2009 dividend payout divided by this year's projected earnings is over 100%, making a dividend reduction for the company a case of, not if, but when. (For a detailed explanation and calculation of the dividend payout ratio, check out Cash Flow Indicator Ratios: Dividend Payout Ratio.)
BB&T seems to be an example of the baby being thrown out with the bath water. The stock has been pounded in the past year, and is down more than 50%, yet when compared to other banks, one could argue that it's not too bad. The bank is well capitalized with a tier-1 ratio of 12%, and a tangible capital ratio of 5.2%. BBT is also mentioned as a "flight to quality" bank.
There is good news surrounding BB&T. The company managed to increase deposits by $2 billion in the fourth quarter, and also raised its dividend. In addition, at these levels, BB&T screams value stock. Trading at less than one time book value, its enterprise value is about four times its market cap. BB&T's payout ratio is 69%, far below that of USB or Wells Fargo (NYSE:WFC), a good sign for the integrity of its dividend. (Value investing is one of the best-known stock-picking methods, read more in Stock-Picking Strategies: Value Investing.)
Calling on Consistency
CenturyTel is one of only 26 S&P 500 companies to raise its dividend for 36 consecutive years, a promising sign for shareholders worried about the viability of the company's payout. The regional telecom provider may operate in a stodgy industry, but it is growing its business and will bolster its bottom line with the acquisition of rival Embarq (NYSE:EQ).
CenturyTel's debt scenario appears manageable, to the point that some analysts recommend the company's bonds over its stock. CTL's $2.80 annual payout also appears to be safe, at least in the short term, and its purchase of Embarq will help it mitigate competitive risks.
Up in Smoke?
Reynolds American, like all of its tobacco rivals, is usually considered a defensive issue in times of market weakness, but that hasn't stopped the market from taking 48% out of the stock in the past year. On the bright side, Moody's Investor Service says the outlook for the tobacco industry in 2009 is "stable" and, in this environment, it's hard to ask for much more than that.
Reynolds, the maker of Camel cigarettes, among other brands, pays a hefty $3.40 annual dividend, and finding any mention of a possible cut is difficult, if not impossible. Despite the fact that federal and state taxes on tobacco products are rising, cigarette makers such as Reynolds appear well-positioned to absorb those hits, and to continue selling their addictive products to a highly loyal customer base.
This is a dividend investors can rely on, as Reynolds corporate policy is to return 75% of net income to shareholders in the form of dividends, making this sin stock a surefire income generator for your portfolio.
Bottom Line: There Are Some Safe Dividends
Even in a market where dividend reductions have become the rule rather than the exception, there are companies that can be counted on to continue rewarding their shareholders. At this point, it appears obvious that USB is not a member of that group, and that BB&T is a minor risk simply due to its industry. Reynolds American is the clear winner here, and its industry also has the best prospects in the short and medium terms, so capital appreciation is another reasonable expectation. (Explore arguments for and against company dividend policy, and learn how companies determine how much to pay out, in How and Why Do Companies Pay Dividends?)
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