Are High Dividends Sustainable?

One of the most popular ways for investors to select stocks is to focus on companies with long track records of increasing dividends. On Feb 27, 2009, General Electric (GE), once the most prominent dividend aristocrat, cut its dividend 68%, the first time since 1938. Who might be next?

I examined four types of high dividend stocks. Please note all these companies have great balance sheets, greater than 3.5% yield, low P/Es, and low short ratios.

1. High Beta Stocks

U.S. unemployment eventually surpassed 10%, consumer spending has scaled back, and more de-leveraging are all major economic headwinds. Consumer spending is likely to be soft for years. The weak labor market could undermine economic recovery.

What we need most, though, are declining unemployment rates, especially in large, populous states, to give the consumer some buyer mojo.

Until that happens, the decoupling of economic data from Wall Street's rally could give the stock market a bumpy ride ahead, or even a “W” shape.

I got rid of criteria #6 and 7 from last week’s article and came out with the following 8 high beta dividend stocks (sorted by beta):

Name	Symbol	P/E	PEG Ratio	Yield	Debt/CF	52-wk Range	Beta
CANADIAN IMP BK CM	(CM)	3.7	1.1	5.20%	1.7	28 - 65	1.55
BANK OF MONTREAL	(BMO)	17.1	1.4	5.20%	5.9	19 - 51	1.39
SASOL LTD ADR	(SSL)	12.3	0.8	4.30%	0.5	19 - 41	1.39
RPM INTL INC	(RPM)	19.3	1.1	4.30%	3.6	9 - 18	1.35
MCGRAW HILL COS	(MHP)	10.6	1.3	3.60%	0.9	17 - 34	1.16
Mattel, Inc.	(MAT)	16.9	1.7	4.10%	1.7	10 - 19	1.12
WILLIS GROUP	(WSH)	12.0	1.0	3.70%	6.6	18 - 33	1.06
ONEOK INC NEW	(OKE)	12.7	2.0	4.60%	5.2	18 - 37	1.06

The 1^st 4 are very volatile: their betas are exceeding 1.35. I owned Bank of Montreal (BMO) and Canadian Imperial Bank of Commerce (CM) for a long time. With such up-and-down and payout ratios exceeding 100%, I might consider selling them when I adjust my allocation next time.

Sasol (SSL) is a South Africa integrated energy and chemical company. Look at its stock and dividend charts below. (Dividend charts includes Oct 2009’s dividend of $0.8.)

RPM's latest dividend increased in October 2008, marking its 35th consecutive year of increased dividends. However, a CFO shakeup, the unsolved of litigation, and concerns over the industry's prospects in this jobless-recovery economy make me wonder when it might cut dividends.

The bottom 4 seem ok to me so far, though Willis Group Holdings (WSH) has too short a dividend history.

2. No/Low Growth Stocks

Dividend growth is a great metric. Companies that raise their dividends are telling investors that business in the near future will be stable.

There are 307 companies which increased their dividends or earnings over at least 10 consecutive years, according to the Staton Institute’s 2009 edition of America's Finest Companies. Hindsight is always 20/20. However, nobody knows which company will be next GE.

I prefer PE/G instead. Dividend growth should be from earnings growth. Without earnings growth, companies that hang on to their high dividends for too long for public relations reasons could end up suffering even more.

Windstream Corporation (WIN), a telecommunications services company, has 9.9% dividend yield. However, it doesn’t have growth data. Centurytel (CTL), another telecommunications company, has a payout ratio of 107%. Without growth, its 8.3% dividend yield might not be sustainable.

Compare to those two, AT&T (T) has a much better growth rate. Still, with its PEG >3, it didn’t make into last week's list.

3. REITs

Dividend coverage ratio is a reverse payout ratio. If the ratio is under 1, the company is using its retained earnings, or even borrowing, to pay this year's dividend.

REITs usually carry high amount of debt. For example, Annaly Capital Management (NLY) has a whopping 15.2% dividend rate. It is the biggest player in “Mortgage Investment” industry, along with Fannie Mae (FNM) and Freddie Mac (FRE). It is very interest rate sensitive and volatile. I will not be surprised if it cuts dividends in tough times ahead.

4. Next Generation “Bellwether" Dividend Stocks?

I used the following criteria to try to find mid-cap stocks with solid dividend growth:

Yield>3.5%; Market cap between $500M and $2B; PE/G<1; Short Ratio<5. Below are 3:

Name	Symbol	P/E	PEG Ratio	Yield
NTELOS Holdings	(NTLS)	13.2	0.98	5.9%
Hudson City Bancorp.	(HCBK)	12.7	0.94	4.6%
MFA FINANCIAL INC.	(MFA)	8.0	0.27	12.6%

NTELOS Holdings has too short dividend history. It is too early to tell.

Hudson City Bancorp and MFA have huge debt load, similar to REITs.

Disclosure: I have long position on BMO and CM. All data is from Yahoo Finance as of Oct 2, 2009.

Comments

[mbkelly75:]

I used to use PEG also. However, in hard times, earnings can be so massaged that they become meaningless. PEG is way more useful than the straight PE, but they are both dependent on an accurate Earnings report. Price to Sales is more useful as Sales are much harder to fool around with. Not impossible to fool with - just harder. I still look at the PEG ratio, but put more weight on P/S. To help find an undervalued stock, I look for P/S =>1.

Oct 04 12:20 PM

[Tack:]

P/E? PEG? Great for growth companies.

For dividend players, especially REITs, the whole ballgame is cashflow.

Oct 04 12:34 PM

[David Van K...:]

mbkelly75: You look for a P/S greater than 1? Valuation ratios get better as they get lower. Did you mean to say =<1?

Oct 04 01:06 PM

[Alan Young:]

You are not making much sense.

Beta is high when investors have fast-changing expectations of a company's profitabililty; it you are depending on it as an indicator of profitability, you are relying on the prescience of other investors rather than any fundamentals that might affect the dividend. This is especially irrelevant when many investors are looking for capital gains or long-term growth rather than dividends, which is the case in all but a few industries.

You also fail to distinguish mortgage REITs from property-management REITs. They have completely different formulas for generating dividends.

And previous comments about the dubious relevance of P/EG also apply.

Oct 04 01:12 PM

[coolsoupy:]

Please don't lump REIT's (Uncle Sam) into your catch all methodology. As long (forseeable future) as the fed has to keep interest rates at near zero I will sock away the dividends. Go NLY, HTS, AGNC Go!!!!!!!!

Oct 04 01:14 PM

[coolsoupy:]

Since I am older than dirt I have changed my investment attitude immensely. The preached wisdom is that seniors need to be very conservative and invest in "safe" low dividend stocks? Hogwash!!
Seniors need to have short term goals and change quickly with the market.

When I buy any stock I am investing (loaning) my money to the company. Am I to trust them to grow the company so I can get a return? In good economic times maybe! Of course that is after they give top managent their cut and squander what they can!

In these uncertain times show me the money. Cliff Watchel has it right and even Peter Schiff.
Pick 12 high dividend stocks with a good smattering of foreign dividend payers like from Canada to protect against the falling dollar and watch your basket of eggs like they were gold!

If 1 out of 12 has a problem you have 8.33% at risk easily covered by the other 11 divy stocks.

Give me a better idea in these uncertain times for oldsters?

Oct 04 01:38 PM

[YoYoMama:]

If cash flow is all-important, we need to be looking at P/CF and P/FCF. This metric, as well as debt load, weigh heavier in my criteria than any others when considering a dividend stock.

Oct 04 03:20 PM

[mbkelly75:]

Thank you - David. Good catch - I did mean =<1 on P/S.

Oct 04 03:36 PM

[KyBec:]

Does anyone here have a case for or against owning PSEC or AOD for their dividend? Do you think the future income stream is safe? I'd like to own both and DRIP them for a long while but am afraid to jump in.

Oct 04 04:36 PM

[a. palmer jr.:]

I wouldn't DRIP anything right now. Of course I'm not an expert stock trader or even a good amateur, but all my dividends go into a money market account until I get enough money to buy something else when it's cheap! I believe that in the future there will be plenty of cheap!

Oct 04 06:00 PM

[bobbybutte:]

You just need to buy great companies at great prices and build yourslf a dividend machine

Oct 04 06:15 PM

[Dotcom:]

Reinvesting dividends is the only way to benefit from compounding. If prices go down, you get more shares at dividend payout time.

Correct me if I'm wrong.

Maybe it works just as well if you take the cash and keep your portfolio balanced by adding to good stocks or investing in additional new dividend paying stocks.

Still learning.


On Oct 04 06:00 PM a. palmer jr. wrote:

> I wouldn't DRIP anything right now. Of course I'm not an expert stock
> trader or even a good amateur, but all my dividends go into a money
> market account until I get enough money to buy something else when
> it's cheap! I believe that in the future there will be plenty of
> cheap!

Oct 04 06:29 PM

[Alan Young:]

Bravo, Coolsoupy! That's telling it like it is.

Strange you should mention Schiff, though. He doesn't believe in changing with the market.

I don't know if it's a "better" idea, but I have half my bets on foreign bonds instead of all stocks.

On Oct 04 01:38 PM coolsoupy wrote:

> Since I am older than dirt I have changed my investment attitude
> immensely. The preached wisdom is that seniors need to be very conservative
> and invest in "safe" low dividend stocks? Hogwash!!
> Seniors need to have short term goals and change quickly with the
> market.
>
> When I buy any stock I am investing (loaning) my money to the company.
> Am I to trust them to grow the company so I can get a return? In
> good economic times maybe! Of course that is after they give top
> managent their cut and squander what they can!
>
> In these uncertain times show me the money. Cliff Watchel has it
> right and even Peter Schiff.
[...]
> Give me a better idea in these uncertain times for oldsters?

Oct 04 06:29 PM

[User 207749:]

I hate to break this news to you..By time you know there is a problem, it's too late. The money has already left! I am a senior investor and have been down this same road many, many times. We are the last to hear when things go wrong.

Now, if you want to sit at your computer ever minute of the trading day, maybe...just maybe you can save yourself a few points. But, the big downward hit will still have passed you by!.


On Oct 04 01:38 PM coolsoupy wrote:

> Since I am older than dirt I have changed my investment attitude
> immensely. The preached wisdom is that seniors need to be very conservative
> and invest in "safe" low dividend stocks? Hogwash!!
> Seniors need to have short term goals and change quickly with the
> market.
>
> When I buy any stock I am investing (loaning) my money to the company.
> Am I to trust them to grow the company so I can get a return? In
> good economic times maybe! Of course that is after they give top
> managent their cut and squander what they can!
>
> In these uncertain times show me the money. Cliff Watchel has it
> right and even Peter Schiff.
> Pick 12 high dividend stocks with a good smattering of foreign dividend
> payers like from Canada to protect against the falling dollar and
> watch your basket of eggs like they were gold!
>
> If 1 out of 12 has a problem you have 8.33% at risk easily covered
> by the other 11 divy stocks.
>
> Give me a better idea in these uncertain times for oldsters?

Oct 04 06:57 PM

[Dotcom:]

207749's last line said -

"Give me a better idea in these uncertain times for oldsters?"

What are your thoughts on where an oldster should have his/her money invested at this time?


On Oct 04 06:57 PM User 207749 wrote:

> I hate to break this news to you..By time you know there is a problem,
> it's too late. The money has already left! I am a senior investor
> and have been down this same road many, many times. We are the last
> to hear when things go wrong.
>
> Now, if you want to sit at your computer ever minute of the trading
> day, maybe...just maybe you can save yourself a few points. But,
> the big downward hit will still have passed you by!.

Oct 04 07:44 PM

[mbkelly75:]

It took 25 years to recover and break even from the Great Depression UNLESS you had dividend-paying stocks AND added money every month (sounds like a DRIP to me). If you did that - it took only 4 years to reach the break-even point. Go head and DRIP in - you will be fine if you keep to the stocks that have been steadily RAISING dividends through it all. That is where the money is over the long-term.

Oct 04 10:21 PM

[FranzSchubert:]

"Hudson City Bancorp and MFA have huge debt load, similar to REITs."
In MFA's case, that is not surprising, since it operates as a REIT and qualifies as a REIT to tax purposes.
The mortgage REITs are in a sweet spot right now, and will be as long as Fed keeps rates low. when it starts rasing rates, then how well the MREITs do depends on a lot of things. Right now, I'm overweight AGNC, NLY, HTS, MFA, CVS, ANH, and CMO and expect to be for the next 6-9 months.

Oct 04 10:51 PM

[pablo256:]

Hao, I enjoyed your article. Do you read the comments? I have been making charts of dividend payers with as many relevant parameters as possible. I have heard that FCF is probably the most important parameter and it seems you did not consider in your article. I am looking at everything with yields between 4.63 and 18 or so. The ETF SDY pays 4.63 so I try not to bother with companies south of that. I dont see the point. Above that I am gathering the parameters, comparing and then researching and reading everything I can to narrow down the list for investing.

Oct 04 11:42 PM

[FranzSchubert:]

Meant CYS, not CVS


On Oct 04 10:51 PM FranzSchubert wrote:

> "Hudson City Bancorp and MFA have huge debt load, similar to REITs."
>
> In MFA's case, that is not surprising, since it operates as a REIT
> and qualifies as a REIT to tax purposes.
> The mortgage REITs are in a sweet spot right now, and will be as
> long as Fed keeps rates low. when it starts rasing rates, then how
> well the MREITs do depends on a lot of things. Right now, I'm overweight
> AGNC, NLY, HTS, MFA, CVS, ANH, and CMO and expect to be for the next
> 6-9 months.

Oct 04 11:58 PM

[cstauffer:]

To all of you "oldsters" I would not recommend short-term trading. To the person who looks at equity investing as "loaning the company money", that is bond investing not stock investing. Don't take equity risk in order to get a bond like return. If you want income invest in a bond fund or buy individual bonds. Buying bonds earlier this year, particularly corporate bonds, would have provided you yields to maturity of between 7% and 12% in very high quality companies. If you are buying equities, buy them for their total return over a 3 -5 year period or longer. Buy dividend paying stocks with a history of an increasing payout ratio and buy the stocks at a low relative P/E. Another way to own equities with a good total return is to purchase a closed end or open end fund which owns dividend paying stocks and combines that strategy with covered call selling. Many of these funds are throwing off annual yeilds between 8-10% and you still have opportunity for appreciation.

Oct 05 08:42 AM

[Robert D.:]

If you are strictly looking for a dividend payer, look into PSEC. They are currently raising (equity) money, most likely for a future acquisition. Expect price to be volatile, however you will also enjoy a fat $1.63 dividend (currently yields over 15%). The dividend appears safe for at least the next 4 quarters.

Oct 05 09:38 AM

[Living4Divi...:]

I agree. Thanks Tack, for adding some common sense to this discussion.

On Oct 04 12:34 PM Tack wrote:

> P/E? PEG? Great for growth companies.
>
> For dividend players, especially REITs, the whole ballgame is cashflow.

Oct 05 10:42 AM

[tk77mann:]

Hao,

You are missing the wonderful benefit of depreciation when looking at dividend sustainability of companies like CTL and WIN. In 2008 CTL had a depreciation expense of $523.8M (all of which is a non-cash expense), versus Capital Expenditure spending of $220.3M. Their Free Cash Flow from this difference (~$300M) is more than enough to cover the $220M in dividends they paid out in 2008. And this does not even include their profits for 2008. With their extra cash flow they bought back $332M worth of stock in 2008, a real bargain since they were also reducing the dividends they have to pay in the future.

Some folks might argue the CTLs and WINs of the world might not be able to keep up spending less than they are depreciating. There are two strong factors that will be used to keep their FCF strong. The first is that these are old line companies with assets invested in the 1980's, 1990's, and recently that have still not been depreciated over their 30 year lives. (These are mainly wireline telecom companies.) The second factor is every time they buy another telecom company they get an entire new slug of assets to be depreciated.

In CenturyTel's case, they just bought Embarq. Even though Embarq had depreciated its assets over the decades, these same assets get written back up to the purchase price and now CTL gets to depreciate them again over the next 30 years. And CTL's cash flow goes on and on.

WIN has recently bought two smaller competitors so they are following a similar strategy (with economy of scale efficiencies thrown in, to boot).

So please do not only look at the Dividend Payout Ratio when looking for sustainable dividends. A Dividend Payout Ration based on Free Cash Flow is at least, if not more, as important.

Oct 05 11:13 AM

[GD:]

Everyone should consider the demise of Fairpoint Communications (FRP} as an example of chasing divs. They recently tanked, going from 20 to nothing. A must read!

Watch your div payers like a hawk---no one else will!

Oct 05 12:14 PM

[tk77mann:]

Fairpoint had way too much debt and took on a huge acquisition (the wireline business of Maine, NH, and Vermont from Verizon), with all new computer systems required. They could not integrate on time and revenues declined and they were not able to recover.

I look at the Net Debt to EBITDA ratio of stocks to see if their debt loads are too high. For me a ratio of anything less than 4 : 1 in a stable industry is a fairly safe bet. But GD is absolutely correct, you have to watch all of your investments to keep losses to a minimum.

Oct 05 12:20 PM

[Augustus:]

I would be a bit cautious on AOD. Look at the premium to BV and it is pretty scarey. They also run an open end mutual fund with the same strategy that would seem to me to be a much better deal.


On Oct 04 04:36 PM KyBec wrote:

> Does anyone here have a case for or against owning PSEC or AOD for
> their dividend? Do you think the future income stream is safe? I'd
> like to own both and DRIP them for a long while but am afraid to
> jump in.

Oct 05 01:09 PM

[OneRichOne:]

I'm real dumb when it comes to investing. But what I look at is div growth. I also don't believe in putting all your eggs in one basket. My strategy has worked well. Say you have $10,000 to invest. Its much better to invest $1.000 in ten stocks than the whole ten grand in one.

Oct 05 07:24 PM

[Hao Jin:]

Yes, I did read most of comments and I learned a lot, such as popularity of FCF/dividend growth and benefit of depreciation, etc. However, I usually didn’t answer questions to individuate stock or allocation, because that is not fair to my paid clients.

I did try to incorporate my responds into my future related articles. Actually this article is a lump/catch-all of my humble opinions to comments posted in my last weeks’ article.

I agree that FCF is one of the most important metric. But I prefer to use operation cash flow(#9 in last article), and I didn’t buy any stocks without looking at CF first.


On Oct 04 11:42 PM pablo256 wrote:

> Hao, I enjoyed your article. Do you read the comments? I have been
> making charts of dividend payers with as many relevant parameters
> as possible. I have heard that FCF is probably the most important
> parameter and it seems you did not consider in your article. I am
> looking at everything with yields between 4.63 and 18 or so. The
> ETF SDY pays 4.63 so I try not to bother with companies south of
> that. I dont see the point. Above that I am gathering the parameters,
> comparing and then researching and reading everything I can to narrow
> down the list for investing.

Oct 05 10:32 PM

[pablo256:]

DivaRisto, Thanks for the TopYields web site. Good information.
Thanks to all others posting good useful info. on the dividend strategy

As part of my dividend search strategy, I am throwing out companies with negative Free Cash Flow and Payout % > 100.
I am looking at many other criteria as well. One that is giving me some pause is companies with Neg. Net Tangible Assets. As I understand it this means that a company owes more than they are worth. I was going to throw them out too, but I see good established companies like At&T (T) and Verizon (VZ) with hugh negative NTA's. Can anyone share a thought on Negative Net Tangible Assest. ???

Oct 05 11:02 PM

[pablo256:]

Does anyone know of a free web site that lists "Monthly dividend payout" companies? I know of a few companies, but would like to get a more comprehensive list before I start comparing data.
It seems that one of the biggest uncertainty is whether a company is going to make the next pay-out or not. Why wait a whole year or six months to find out. If it pays monthly you will know soon enough.
Thanks - Pablo.

Oct 06 10:55 PM

[Robert D.:]

If your concern is debt, look into TICC. They are buying back shares, hold 0 debt, and cash levels have doubled since Dec 31, 2008.
Divi? 11.9%

Oct 07 09:36 AM