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Some investors like to chase high dividend yields. These often prove unsustainable, and in some cases, incur large capital losses. But just because a dividend yield is a more reasonable 3 – 6%, this does not necessarily mean risk is eliminated.

The income investor will want to look at payout ratios to see if there is margin to increase in bad markets or if prices pull away from earnings. If not and the PE ratios start climbing, yields may actually drop. Another aspect to consider is the consistency of increasing dividend payouts over time.

  • Allete (NYSE:ALE)

EPS declined from 2007 – 2010. That being said, the year over year quarterly revenue and EPS growth is up 25.3 and 22.5% respectively. The payout ratio is 74%, giving them a little bit of room to up the dividend if necessary, and they did so recently. However, the price is also climbing, making the yield hold at 4.75% -- which is nothing to complain about. Even as the PE ratio has dropped slightly since late 2009, we would expect an inverse proportioned move upwards in yield. Yet, yields have slowly declined showing that they must be lowering their payout ratio slightly over time. I guess they are erring on the side of safety, which isn’t a bad thing.

  • DNB Financial Corp (NASDAQ:DNBF)

This is an example of what you don’t want to see as an income investor. Prices plummeted in 2007 and 2008, but as they now experience record EPS highs, the dividend yields are at terrible lows of 1.1%. This shows that the 4 – 6% dividend yield range shown on a chart, while prices were plummeting, is not a realistic yield about to be seen any time soon on this stock. Unless they decide to boost the payout ratio past the current 13%, this can hardly be viewed as an income investing pick despite the brief high yield.

  • AstraZeneca (NYSE:AZN)

When looking at the rolling EPS over the past 10 years, they have increased from under $2 per share up to over $6. Their payout ratio is only listed as 44% gives them a lot of room. Earnings have tripled over the past decade but share price is flat. This quashed PE ratios from 30 to under 9 which should give this company an easier time paying continued dividends in the future, despite some flat future growth expected between this and next year. There are no doubt worries on the US healthcare reform, as well as generics eating up revenues. Still, this company has shown a good history of growing EPS, even if helped by share buybacks. While this stock may not excite the capital growth investor and may not trade higher anytime soon, it is a decent choice by true income investors wanting high earnings, low payout ratio, and a long history of EPS growth. Oh right, the trailing annual dividend yield of 4.9% isn’t bad either.

As always, do your homework on any stock before buying.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Two Big Dividend Earners and One to Avoid