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. Home & Auto

    Understanding Rent-to-Own Contracts

    They can work for you or against you. Here's how to negotiate a fair one.
  2. 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.
  3. 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.
  4. 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.
  5. Home & Auto

    Renting vs. Owning: Which is Better for You?

    Despite the conventional wisdom, renting might make more financial sense than you think.
  6. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  7. Fundamental Analysis

    Calculating Return on Net Assets

    Return on net assets measures a company’s financial performance.
  8. Economics

    Explaining the Participation Rate

    The participation rate is the percentage of civilians who are either employed or unemployed and looking for a job.
  9. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  10. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
RELATED TERMS
  1. Theta

    A measure of the rate of decline in the value of an option due ...
  2. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
  3. International Financial Reporting ...

    A set of international accounting standards stating how particular ...
  4. Days Sales Outstanding - DSO

    A measure of the average number of days that a company takes ...
  5. Equity

    The value of an asset less the value of all liabilities on that ...
  6. Derivative

    A security with a price that is dependent upon or derived from ...
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... 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!