The basis of stock valuation is that a stock is valued based on the future expectation of cash that the owners of the common stock expect to receive. A business has two options as to what to do with that cash flow: reinvest it back in the business or pay it out as a dividend. As we've seen, those cash flow expectations can be widely distorted during boom and bust times.

IN PICTURES: 20 Tools For Building Up Your Portfolio

Dividends Can Be Counted
However, dividends are real and tangible. A company cannot hide a dividend. It's either paid or it's not. In today's world of virtually non-existent earnings growth, dividends can be extremely significant. And many dividend yields today provide extremely attractive returns not often considered for the most conservative investor. (For more, see Dividend Yield For The Downturn.)

A Healthy Yield Dose
The healthcare industry offers investors many attractive yields today. In addition, the relative underperformance of the industry over the past few years also gives investors the possibility of capital gain in the stock. Many smart money managers, like Bruce Berkowitz at Fairholme, have been jumping on the healthcare bandwagon, convinced that the end result of the Obama healthcare plan will a bigger pool of insured recipients.

Ely Lilly (NYSE:LLY) currently sports a 5.8% yield. The company pays about $2 billion in dividends, protected by over $7 billion in operating cash flows in 2008. For the past three years operating cash flows have covered the dividend payout by more than two times. In the meantime, annual interest payments of $228 million means that investors can be comforted by the security of the dividend. One of Fairholme's largest postions, Pfizer (NYSE:PFE), currently yeilds 4.3% and a P/E of 12. Listening in on a recent Fairholme conference call, I learned that Pfizer, through a series of acquisitions, has become the fourth largest generic drug comapny.

AT&T (NYSE:T) offers income-oriented investors a blue chip name with a dividend yield rarely found in a company of its size and stature. At 6.8%, the dividend is at a historically high level. I doubt shares in AT&T will deliver outsized capital gain, but the shares do trade near their 52-week lows. The P/E is 11.5, and if AT&T shares appreciate by 4% to 5% a year, the dividend yield gives you a stock that is delivering double digit annual returns. (And that's the hidden value of dividends. For more, see The Power Of Dividend Growth.)

A Rare Oil Play
Despite the recent rally in oil, shares in oil giant ConocoPhillips (NYSE:COP) have stayed back. Warren Buffett was buying Conoco when it was trading in the $80s, though he has admitted that it was a mistake to buy Conoco at those prices. Today, the shares are at $43 and the dividend is at 4.3%. Conoco is one of those companies that does offer investors both a strong yield and a very good chance of a strong appreciation in stock price over the next several years. Conoco has a wonderful refining segment that benefits from lower oil prices. But the long-term outlook for oil remains positive thanks to growth of the emerging economies. (For further reading, check out A Guide To Investing In The Oil Markets.)

Bottom Line
When it comes to dividends, two things matter most: first, the underlying company should possess strong attributes to deliver solid operating performance, and second, the security of the dividend should always precede the rate of the dividend. A 5% yield doesn't mean much if underlying business is weak and shares continue to decline. Likewise, a high yield that's only good for a quarter or two is less desirable than a satisfactory yield that can be counted on for years. (For more, see The Importance Of Dividends and Build A Dividend Portfolio That Grows With You)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Term

    What are Non-GAAP Earnings?

    Non-GAAP earnings are a company’s earnings that are not reported according to Generally Accepted Accounting Principles.
  2. Term

    What are Mutually Exclusive Events?

    In statistics, mutually exclusive situations involve the occurrence of one event that does not influence or cause another event.
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  5. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  6. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Corp Bd

    Learn about the Vanguard Intermediate-Term Corporate Bond ETF, and explore detailed analysis of the fund's characteristics, risks and historical statistics.
  7. Home & Auto

    Understanding Rent-to-Own Contracts

    They can work for you or against you. Here's how to negotiate a fair one.
  8. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  9. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  10. Home & Auto

    Avoiding the 5 Most Common Rent-to-Own Mistakes

    Pitfalls that a prospective tenant-buyer could encounter on the road to purchase – and how not to stumble into them.
RELATED TERMS
  1. Implied Volatility - IV

    The estimated volatility of a security's price.
  2. Plain Vanilla

    The most basic or standard version of a financial instrument, ...
  3. Operating Cost

    Expenses associated with the maintenance and administration of ...
  4. Trade Credit

    An agreement where a customer can purchase goods on account (without ...
  5. Normal Profit

    An economic condition occurring when the difference between a ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  3. What are some examples of general and administrative expenses?

    In accounting, general and administrative expenses represent the necessary costs to maintain a company's daily operations ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. How do dividend distributions affect additional paid in capital?

    Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued: ... Read Full Answer >>
  6. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!