Big Dividends, Small Risk

By Sham Gad | October 31, 2011 AAA

Over time dividends create enormous value. By some estimates, nearly one half of the total return from the S&P 500 over the past 100 years comes as a result of dividends. Dividends matter a lot, but only when they can be counted on year in and year out. Banks were known for their steady dividends, but then the financial crisis hit in 2008 and virtually all banks had to eliminate dividend payments. Very few have brought them back; however, a few companies still maintain dividends, some of which have been increasing in spite of the market downtown.

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Rock Solid Yields
A dividend payment represents a return of cash, and is only as good as its reliability. The best and most reliable dividends naturally come from companies that are conservatively financed, and have reliable business operations. Debt holders are paid well before common stock dividend holders, so a highly levered company is always at risk of eliminating a dividend payment.

There is little concern with the dividend payment at defense giant Lockheed Martin (NYSE: LMT), one of the most highly respected defense companies. Dividends have been increasing for nearly 12 years. At today's current prices, the dividend yield is strong at a 5.1% for a company that is well established as LMT. Trading at a P/E less than 10 times earnings, the valuation is also solid with minimal chance of any significant long-term share price decline. Consumer giant Johnson and Johnson's (NYSE:JNJ) forward dividend yield of 3.6% may arguably be one the most reliable dividends in corporate America. JNJ has paid a dividend for decades without missing a payment. The yield is significantly higher than the U.S. Treasury's, but over the long term JNJ shares may be just as safe. (For an article on the ins-and-outs of dividends, check out How And Why Do Companies Pay Dividends?)

Going Global

Big, safe dividends are not only available in the U.S. Telecommunication giant Vodafone (Nasdaq:VOD) is another non-utility large cap with a yield just above 5%. Consistent and stable cash flows generated from wireless subscriptions ensure the consistency of the dividend. Another dividend payout from a well-entrenched company is the 3% yield from U.K. based spirits company Diageo (NYSE:DEO). Diageo may be one of few stocks that would be suitable for any portfolio. The stability of its business offers protection. The growth from the company's international markets provides long-term upside.

The Bottom Line
The comfort of holding cash that earns zero interest can be misguiding since the purchasing power of the dollar declines over time. Quality, cash flow generating business that payout attractive dividends can offer reasonable substitutes for holding cash for those investors with a time horizon of several years.

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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

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