For investors currently evaluating dividend stocks, there really are a lot of attractive options. The average yield of dividend stocks in the Dow Jones index is now 2.9%. The S&P 500 sports 15 stocks with dividend yields above 6%. Those are pretty attractive yields for income investors, given that a money market account currently offers less than a 1% return. However, many dividend investors automatically ignore high yielding dividend stocks as they assume that such high yields are too good to be true.
Of course there is much more to evaluating a dividend stock than just looking at its yield. Intelligent investors will look not only at a stock’s yield, but also at their payout ratio or the ratio of dividend payments to net earnings. A high dividend payout ratio is typically a warning sign that the current dividend level is unsustainable. However, eDividendStocks.com has taken a look at 5 dividend stocks that are dangerously high, but also have very deceiving payout ratios. These 5 dividend stocks offer investors impressively high dividend yields, and they have sufficient free cash flow to maintain their dividend payments.
Qwest Communications (Q)
Qwest offers dividend investors an impressive 6.9% dividend yield. Wall Street expects that net earnings will decline by 10% this year, pushing the stock’s dividend payout ratio to 94%. However, the company generated nearly $2 billion in free cash flow in 2009 and has very impressive EBITDA margins (36% in the fourth quarter). With a manageable dividend/free cash flow ratio, Qwest should be able to maintain their dividend payout despite Wall Street’s expectations of further revenue declines in 2010 and 2011.
Frontier Communications (FTR)
Frontier Communications is the highest yielding stock in the S&P 500 with an amazing 13.7% dividend yield. The telecom stock is in the midst of acquiring assets from Verizon (VZ) in an $8.6 billion deal. Once the transaction is completed the company will reduce their dividend to $.75 per year. The dividend reduction along with the Verizon transaction will significantly improve their dividend payout ratio from their current 175% level, but will still offer investors an amazing 10% dividend yield.
Windstream is the second highest yielding dividend stock in the S&P 500 with a 9.6% dividend yield. While the company’s annual dividend payout of $1.00 per share exceeds their anticipated net earnings of $.85 per share, the telecom stock is only expected to pay out 55% of their free cash flow in 2010. Wall Street also expects the stock to grow earnings in both 2010 and 2011.
Paychex currently offers investors a respectable 4% dividend yield, but at the same time they are using 93% of their net earnings to fund their dividend payment. However, Wall Street expects the company’s earnings to grow by 8% in 2011. Though the labor markets are still a long way from full recovery, investors are recognizing that the Paychex outlook is much brighter than it was just a few quarters ago.
While Verizon may be the second highest yielding dividend stock in the Dow Jones index, declining earnings in 2010 could put pressure on the company’s high dividend. However, given the company’s strong dividend history we believe a dividend cut is unlikely from Verizon - despite a dividend payout ratio that is now above 80%. A costly marketing battle with AT&T (T) could prevent Verizon from increasing their dividend this year, but the chances of a dividend cut are slim.
When evaluating dividend stocks, free cash flow is often a much better measure to look at than net earnings. Without looking at a company’s cash flow, you can often be ignoring great dividend stocks. A high dividend payout ratio certainly shouldn’t preclude you from doing further analysis on a great dividend opportunity.
Disclosure: No Positions
Disclosure: No Positions