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Dividend sustainability is paramount for the high-yield investor. Having a stock cut its dividend could potentially crush their income. A high-yield investor is less concerned about dividend growth than maintaining the current high-yield. Most traditional dividend growth stocks pay a moderate to low yield. Thus, sustainability is not enough – the dividend growth investor also expects substantial and consistent growth.

This expectation does not change even when the economy turns down and earnings decline; dividend growth investors still require annual dividend growth. The companies that are able to accomplish this are those with a operating model that generates strong free cash flows with room to pay out a higher percentage as dividends. Below are several companies with a low free cash flow payout (below 40%):

Current FCF
Company Yield Payout
Cardinal Health (NYSE:CAH) 2.44% 11.01%
Diebold, Inc. (NYSE:DBD) 3.30% 17.21%
General Dynamics (NYSE:GD) 2.54% 25.84%
PPG Industries, (NYSE:PPG) 2.84% 26.16%
Medtronic Inc. (NYSE:MDT) 2.52% 27.88%
ADP, Inc. (NASDAQ:ADP) 3.08% 30.34%
Procter & Gamble (NYSE:PG) 3.04% 31.30%
Intel Corporation (NASDAQ:INTC) 3.19% 32.05%
Abbott Labs (NYSE:ABT) 3.27% 34.76%
Genuine Parts (NYSE:GPC) 3.45% 39.57%

An interesting twist to the above is a 2006 study conducted by Credit Suisse that found high dividend yield stocks generally outperformed those with lower yields. However, the best returns did not come from those with the highest yields, but those with higher yields coupled with low payout ratios. The study found that high yield, low payout stocks that produced the better returns were priced at low ratios of price-to-earnings, and as a corollary, at high ratios of earnings-to-price; i.e., earnings yield. Put another way, the stocks prices were depressed, thus creating the higher yield and a value play.

Below are several dividend growth stocks with a higher yields (around 4%+) and low free cash flow payouts (50% and below):

Current FCF
Company Yield Payout
Integrys Energy (NYSE:TEG) 5.09% 24.43%
Pitney Bowes Inc. (NYSE:PBI) 6.60% 43.01%
Atmos Energy (NYSE:ATO) 4.60% 46.64%
Cincinnati Finl. (NASDAQ:CINF) 5.21% 46.87%
Eli Lilly and Co. (NYSE:LLY) 5.54% 50.33%
Federated Investors (NYSE:FII) 4.02% 39.92%
Harleysville Grp (NASDAQ:HGIC) 3.95% 34.72%

At some point we will all want to retire, but that is not to say we want our portfolio to stop working for us. A good dividend growth stock portfolio will not only provide us income in our retirement, but provide us more income each year than the one before.

Full Disclosure: Long GD, MDT, ADP, PG, INTC, ABT, GPC, TEG, CINF, LLY, HGIC. See a list of all my income holdings here.

Source: 17 Stocks With Room to Grow Dividends