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Investing in dividend-paying stocks makes sense for the following reasons

  1. A steady income without having to sell your position
  2. Provides you with more financial flexibility.
  3. It's a good hedge against inflation
  4. Cash Flow regardless of market direction.
  5. Quicker compounding.
  6. Provides with the two potential sources of income; one from capital gains and the other from the dividends paid out
  7. You can also open up additional streams of income by selling covered calls.
  8. If you are bullish on the stock you can open up an additional stream of income by selling puts.

Investors should take the time to understand the following key ratios as many of them have been used in this article; getting a handle on these ratios could mean the difference of choosing a winner or a loser.

Enterprise value is a combination of the market cap, debt, minority interests, preferred shares less total cash and cash equivalents. This provides a better picture because it is a more accurate representation of a company's value contrary to simply looking at the Market cap.

Free cash flow yield is obtained by dividing free cash flow per share by the current price of each share. Generally lower ratios are associated with an unattractive investment and vice versa. Free cash flow takes into account capital expenditures and other ongoing costs associated with the day to day to functions of the business. In our view free cash flow yield is a better valuation metric then earnings yield because of the above factor

Levered free cash flow is the amount of cash available to stock holders after interest payments on debt are made. A company with a small amount of debt will only have to spend a modest amount of money on interest payments, which in turn means that there is more money to send to shareholders in the form of dividends and vice versa.

Operating cash flow is generally a better metric than earnings per share because a company can show positive net earnings and still not be able to properly service its debt; the cash flow is what pays the bills.

The payout ratio tells us what portion of the profit is being returned to investors. A pay out ratio over 100% indicates that the company is paying out more money to shareholders, then they are making; this situation cannot last forever. In general if the company has a high operating cash flow and access to capital markets, they can keep this going on for a while. As companies usually only pay the portion of the debt that is coming due and not the whole debt, this technique/trick can technically be employed to maintain the dividend for sometime. If the payout ratio continues to increase, the situation warrants close monitoring as this cannot last forever; if your tolerance for risk is a low, look for similar companies with the same or higher yields, but with lower payout ratios. Individuals searching for other ideas might find this article to be of interest Williams Companies: There Are Better Pipeline Plays

Inventory turnover is calculated by dividing sales by inventory. If a company generated $30 million in sales and had an average inventory of $6 million; the inventory turn over would be equal to 5. This value indicates that there are 5 inventory turnovers per year. This means that it takes roughly 2.4 months to sell the inventory. A low inventory turnover is a sign of inefficiency and vice versa.

Price to tangible book is obtained by dividing share price by tangible book value per share. The ratio gives investors some idea of whether they are paying too much for what would be left over if the company were to declare bankruptcy immediately. In general stocks that trade at higher price to tangible book value could leave investors facing a great percentage per share loss than those that trade at lower ratios. The price to tangible book value is theoretically the lowest possible price the stock would trade to

Interest coverage is usually calculated by dividing the earnings before interest and taxes for a period of 1 year by the interest expenses for the same time period. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. Additional key metrics are addressed in this article "5 Great Plays With Yields As High As 13%"

Reynolds American Inc (NYSE: RAI) is our favorite for the following reasons:

  1. Net income, total cash flow from operating activities and sales has generally been trending upwards for the past 4 years.
  2. It sports a strong interest coverage ratio of 10.65
  3. It has a good current ratio of 1.10
  4. Lt Debt to equity is 48%
  5. A very strong 3 year total return of 126%
  6. A strong 5 year dividend growth rate of 9.52%
  7. A 5 year dividend average o 5.6%
  8. A healthy ROE of 22%
  9. A very strong levered free cash flow of $1.4 billion
  10. It recently announced a dividend hike of 5.7%; this is an indication that business is still strong

$100K invested in RAI for 10 years would have grown to $395K

Stock

Dividend Yield

Market Cap

Forward PE

EBITDA

Quarterly Revenue Growth

Beta

Revenue

Operating Cash flow

ABB

3.20%

48.2B

12.56

5.44B

18.10%

1.37

36.60B

3.70B

PG

3.30%

179.7B

14.86

18.54B

3.7%

0.4

85.1B

13.3B

RAI

5.60%

23.7B

12.80

2.66B

0.11%

0.59

8.53B

1.1B

BMY

4.30%

54.2B

16.51

7.62B

6.7%

0.38

21.24B

4.87B

NS

7.50%

3.84B

17.6

500.03M

61.40%

0.72

6.58B

283.54M

ABB Ltd

Industry: Electrical Equipment

The dividend was increased from 47 cents to 67 cents and it also has a high beta which makes it a good candidate for covered writes.

Net income for the past three years

2008 = $3.12 billion

2009 = $2.9 billion

2010 = $2.56 billion

Total cash flow from operating activities

2008 = $3.96 billion

2009 = $4.03 billion

2010 = $4.2 billion

Key Ratios

P/E Ratio=16.40

P/E High - Last 5 Yrs=28.6

P/E Low - Last 5 Yrs=6.7

Price to Sales=1.36

Price to Book=3.18

Price to Tangible Book=7.83

Price to Cash Flow=12.10

Price to Free Cash Flow=-29.30

Quick Ratio=0.9

Current Ratio=1.3

LT Debt to Equity=0.15

Total Debt to Equity=0.29

Interest Coverage=22.3

Inventory Turnover=4.2

Asset Turnover=1

ROE =20.59%

Return on Assets=7.64%

Current Ratio=1.34

Total debt=4.62B

Book value=6.91

Qtrly Earnings Growth=2.10%

Dividend yield 5-year average=2.90%

Dividend rate=$ 0.57

Payout ratio =51%

Dividend growth rate 3-year avg=49.00%

Dividend growth rate 5-year avg=75.68%

Consecutive dividend increases=2 years

Paying dividends since=2003

Total return last 3 years=71%

Total return last 5 years =29%

Notes

Dividend was increased from 48 cents to 67 cents. It has a very good interest coverage ratio of 22.3, a favorable current ratio of 1.3, a great 5 year dividend growth rate of 75.68% and a strong 3 year total return of 71%

Procter & Gamble Co.

Industry : Household & Personal Products

It has a levered free cash flow rate of $7.69 billion and a current ratio of 0.79. PG is a true dividend champion.

Net income for the past three years

2009 = $13.44 billion

2010 = $12.74 billion

2011 = $11.8 billion

Total cash flow from operating activities

2009 = $14.92 billion

2010 = $16.08 billion

2011 = $13.24 billion

Key Ratios

P/E Ratio = 19.0

P/E High - Last 5 Yrs = 21.8

P/E Low - Last 5 Yrs = 9.6

Price to Sales = 2.09

Price to Book = 2.82

Price to Tangible Book = -7.88

Price to Cash Flow = 14.00

Price to Free Cash Flow = 49.60

Quick Ratio = 0.4

Current Ratio = 0.8

LT Debt to Equity = 0.31

Total Debt to Equity = 0.53

Interest Coverage = 17.60

Inventory Turnover = 5.4

Asset Turnover = 0.6

ROE = 15.5%

Return on Assets = 7.24%

Current Ratio = 0.83

Total debt = 33.85B

Book value = 23.27

Qtrly Earnings Growth = -49%

Dividend yield 5-year average = 2.8%

Dividend rate = $ 2.10

Payout ratio = 53%

Dividend growth rate 3-year avg = 9.49%

Dividend growth rate 5-year avg = 11.13%

Consecutive dividend increases = 58 years

Paying dividends since = 1891

Total return last 3 years = 23.61%

Total return last 5 years = 12.68%

Notes

A dividend champion that has consecutively increased dividends for 58 years; it also sports a healthy 5 year dividend growth rate of 11%, a strong interest rate coverage ratio of 17.16 and has a manageable payout ratio of 53%

Reynolds American Inc

Industry: Tobacco Products

It has a strong levered free cash flow rate of 1.42 billion and a current ratio of 1.09

Net income for the past three years

  1. 2008= $1.33 billion
  2. 2009 =$962 million
  3. 2010 = $1.13 billion
  4. 2011= it stands at $1.024 billion and could potentially top the $1.4 billion mark.

Total cash flow from operating activities

  1. 2008= $1.31 billion
  2. 2009 =$1.45 billion
  3. 2010 = $1.26 billion
  4. 2011= It stands at roughly $841 million.

Key Ratios

P/E Ratio = 19.0

P/E High - Last 5 Yrs = 21.8

P/E Low - Last 5 Yrs = 9.6

Price to Sales = 2.09

Price to Book = 2.82

Price to Tangible Book = -7.88

Price to Cash Flow = 14.00

Price to Free Cash Flow = 49.60

Quick Ratio = 0.5

Current Ratio = 1.10

LT Debt to Equity = 0.48

Total Debt to Equity = 0.55

Interest Coverage = 10.50

Inventory Turnover = 4.60

Asset Turnover = 0.5

• ROE 22%

• Return on assets 9.8%

• Total debt 3.67B

• Book value 11.52

• Qtrly Earnings Growth -1.6%

• Dividend yield 5-year Average 6.10%

• Dividend rate $ 2.24 %

• Payout ratio 90.00%

• Dividend growth rate 3-year average 8.33%

• Dividend growth rate 5-year average 9.52%

• Consecutive dividend increases 2 years

• Paying dividends since 2004

• Total return last 3 years 126%

• Total return last 5 years 52%

Notes

A good interest coverage ratio of 10.5, a decent current ratio of 1.10 a strong 3 year total return of 126% and decent 5 year dividend growth rate of 9.52%. The high payout ratio is a bit of concern but it's still below 100% and RAI generates more than enough cash flow to cover its dividend payments.

Bristol-Myers Squibb Co.

Industry: Pharmaceuticals

BMY is another true dividend champion with a levered free cash flow rate of $5.25 billion and a current ratio of 2.03.

Net income for the past three years

2008 = $5.25 billion

2009 = $10.62 billion

2010 = $3.11 billion

Total cash flow from operating activities

2008 = $3.71 billion

2009 = $4.07 billion

2010 = $4.5 billion

Key Ratios

P/E Ratio = 14.8

P/E High - Last 5 Yrs = 29.7

P/E Low - Last 5 Yrs = 6.1

Price to Sales = 2.54

Price to Book = 3.26

Price to Tangible Book = 6.91

Price to Cash Flow = 12.00

Price to Free Cash Flow = 42.40

Quick Ratio = 1.6

Current Ratio = 2

LT Debt to Equity = 0.33

Total Debt to Equity = 0.34

Interest Coverage = 39.8

Inventory Turnover = 3.6

Asset Turnover = 0.7

ROE = 32.8%

Return on Assets = 13.51%

Current Ratio = 2.03

Total debt = 5.62B

Book value = 9.78

Qtrly Earnings Growth = 76.4%

Dividend yield 5-year average = 4.9%

Dividend rate = $ 1.36

Payout ratio = 61%

Dividend growth rate 3-year avg = 2.37%

Dividend growth rate 5-year avg = 3.52%

Consecutive dividend increases = 4 years

Paying dividends since = 1900

Total return last 3 years = 56.33%

Total return last 5 years = 47.08%

Notes

It has a good quick ratio of 1.6, a strong current ratio of 2.00 and a very good interest coverage ratio of 39.8. It also sports a strong ROE of 32%, a manageable payout ratio of 61% and has been paying dividends since 1900. The dividend was increased from 33 cents to 34 cents.

NuStar Energy L.P.

Industry : Refining & Marketing

It has a levered free cash flow rate of $283 million and a current ratio of 1.2

Net income for the past three years

2008 = $254.02 million

2009 = $224.88 million

2010 = $238.97 million

2011= it stands at $191 million and could top the $261 million mark.

Total cash flow from operating activities

2008 = $485.19 million

2009 = $180.59 million

2010 = $362.5 million

Key Ratios

P/E Ratio = 18.90

P/E High - Last 5 Yrs = 26.1

P/E Low - Last 5 Yrs = 6.4

Price to Sales = 0.65

Price to Book = 1.52

Price to Tangible Book = 2.36

Price to Cash Flow = 9.70

Price to Free Cash Flow = -8.60

Quick Ratio = 0.5

Current Ratio = 1.2

LT Debt to Equity = 0.86

Total Debt to Equity = 1.01

Interest Coverage = 4.1

Inventory Turnover = 10.2

Asset Turnover = 1.1

ROE = 8.48%

Return on Assets = 3.81%

Total debt = 2.57B

Book value = 37.98

Qtrly Earnings Growth = -41.4%

Dividend yield 5 year average = 7.3%

Dividend rate = $ 4.36

Payout ratio = 138%

Dividend growth rate 3-year avg = 2.67%

Dividend growth rate 5-year avg = 4.57%

Consecutive dividend increases = 10 years

Paying dividends since = 2001

Total return last 3 years = 48.2%

Total return last 5 years = 30.33%

Conclusion

The markets are still overbought and long-term investors should wait for a healthy pull back before committing large sums of money to this market. The SPX should test the 1250-1280 ranges and could possibly trade as low as 1220.

EPS charts were sourced from zacks.com and dividend history charts were sourced from dividata.com

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

Disclaimer: This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware.

Source: 5 Splendid Plays With Superb Yields As High As 7.5%