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When many investors think of stable dividends, they think utility stocks. Many investors wrongly believe that the dividends and equity returns of utility stocks are guaranteed by the government. This is not true. In fact, utilities have gone bankrupt in the past and may do so from time to time in the future. They are not risk free.

As it turns out, many top dividend utility stocks, including Artesian Resources (NASDAQ:ARTNA), Central Vermont Public Service (NYSE:CV), Verizon (NYSE:VZ), FirstEnergy Corp. (NYSE:FE), Otter Tail Corporation (NASDAQ:OTTR), and Progress Energy (NYSE:PGN) have precariously high dividend payout ratios and weak Altman Z-scores.* Do dividend investors have better alternatives for income generating stocks?

As it turns out, investors have options. As alternatives to these utilities, stocks across sectors were screened based on the following criteria:

A payout ratio under 0.60. These firms have more earnings from which to reinvest in the firm or increase dividend payments.

A "safe" Altman Z-score. None of these alternative firms are alarming bankruptcy risks.

Dividend yield. Each stock pays a dividend yield of at least 2.5%, which is in excess of the 10-year treasury bond and the dividend yield of the S&P 500.

Long term historical return on equity. Each of these stocks has positive average ROE over the past 10 years. This criterion filters for stocks which were able to endure and prosper over the economic downturn. Furthermore, this long term history filters out firms that are experiencing a short burst of good fortune.

Reasonable valuations. Stocks with lower price-to-earnings ratios than the aforementioned utilities were found to help dividend investors consider them as alternatives. Price-to-book ratios were capped at two.

The resulting dividend paying stocks are listed below along with these rough utility stocks which are provided for comparison:

Ticker

Company

Industry

10-Year Average ROE

Altman Z-score

Payout Ratio

(NASDAQ:AMAT)

Applied Materials Inc.

Semiconductor Equipment & Materials

11.4%

5.16

0.27

(NYSE:BBY)

Best Buy Co. Inc.

Electronics Stores

21.3%

3.27

0.21

(NYSE:CVX)

Chevron Corporation

Major Integrated Oil & Gas

20.2%

4.56

0.23

(NYSEMKT:FRD)

Friedman Industries Inc.

Steel & Iron

11.9%

7.83

0.37

(NYSE:KSS)

Kohl's Corp.

Department Stores

16.6%

3.79

0.23

(NYSE:LXK)

Lexmark International Inc.

Computer Based Systems

26.6%

3.15

0.06

(NASDAQ:MANT)

ManTech International

Security Software & Services

12.0%

3.93

0.23

(NASDAQ:NAFC)

Nash Finch Co.

Food Wholesale

8.5%

5.58

0.20

(NYSEMKT:NHC)

National Healthcare Corp.

Long-Term Care Facilities

13.8%

3.44

0.29

(NASDAQ:SPAN)

Span-America Medical Systems Inc.

Medical Appliances & Equipment

15.9%

8.49

0.29

(NASDAQ:SPLS)

Staples, Inc.

Specialty Retail, Other

16.4%

4.12

0.28

(NASDAQ:TCCO)

Technical Communications

Communication Equipment

13.6%

12.04

0.27

(NASDAQ:TESS)

TESSCO Technologies Inc.

Electronics Wholesale

9.5%

5.75

0.27

(NYSE:UVV)

Universal Corp.

Tobacco Products, Other

13.2%

3.16

0.57

(NYSE:WAG)

Walgreen Co.

Drug Stores

17.5%

5.68

0.27

(ARTNA)

Artesian Resources Corp.

Water Utilities

8.6%

0.68

1.21

(CV)

Central Vermont Public Servic

Electric Utilities

7.1%

1.27

2.26

(FE)

FirstEnergy Corp.

Electric Utilities

11.0%

0.94

1.04

(OTTR)

Otter Tail Corporation

Diversified Utilities

9.7%

1.60

2.67

(PGN)

Progress Energy Inc.

Electric Utilities

8.8%

1.00

1.08

These alternative stocks are all categorized as "safe" according to the Altman Z-score, indicating that they are not considered bankruptcy risks. This is in contrast to ARTNA, CV, FE, OTTR, and PGN, which have scores that qualify as "distressed." Moreover, the average 10-year return on equity (from the last ten reported fiscal years) demonstrates that these stocks a track record of growing shareholder wealth. It is clear from these two metrics that each of these four alternative stocks is a "high" quality stock capable of weathering bad times and delivering positive long-term results.

Our screen discovered alternative stocks are trading at cheaper price ratios than their utility sector counterparts:

Ticker

Dividend Yield

P/E

P/S

P/B

P/FCF

AMAT

2.6%

10.43

1.56

1.81

10.07

BBY

2.6%

8.56

0.17

1.51

3.87

CVX

3.0%

8.14

0.85

1.79

25.58

FRD

5.0%

7.78

0.45

1.15

22.96

KSS

2.7%

11.03

0.65

1.88

12.93

LXK

2.8%

8.69

0.61

1.83

10.79

MANT

2.5%

9.12

0.43

1.12

8.35

NAFC

2.6%

8.07

0.07

0.83

11.51

NHC

2.7%

11.22

0.81

1.03

19.36

SPAN

2.7%

11.51

0.79

1.81

13.44

SPLS

2.6%

11.01

0.43

1.53

11.69

TCCO

3.7%

7.5

1.44

1.4

5.96

TESS

2.9%

11.44

0.24

1.76

21.28

UVV

4.3%

15.18

0.43

0.9

10.01

WAG

2.7%

11.12

0.39

1.95

23.01

ARTNA

4.0%

24.25

2.53

1.49

0

CV

2.6%

86.12

1.34

1.75

0

FE

4.9%

20.96

1.15

1.41

0

OTTR

5.6%

47.29

0.71

1.31

0

PGN

4.7%

27.18

1.77

1.57

0

The utility sector might be the most famous sector for dividend yields, but there are many other stocks with dividend yields which hail from other sectors. Investors who dare to screen other stocks might find security based on financial stability and low payout ratios rather than the perception of a stable sector.

Better yet, these firms are trading at cheaper price multiples. Income investors ought to consider these alternative stocks as additions to their income portfolios. Moreover, they ought to carefully consider the safety of the utilities in this article and their distributions. Don't assume they are guaranteed.

*The Altman Z-Score is a measure of bankruptcy risk that is not based on stock price volatility. This score places companies into three groups: "safe" (Z-score > 2.99), "grey" (Z-score between 2.99 and 1.81), and "distressed" (Z-score < 1.81), and is surprisingly useful for identifying bankruptcy risk in the coming year. This method of segmenting companies uses of fundamental (financial statement) data and market capitalization only, not on price volatility. Beyond credit risk prediction, companies with higher Z-scores have historically outperformed companies with lower Z-scores, in aggregate. One sector has not been accurately modeled: Altman's Z-score has not accurately predicted the bankruptcy risk of financial companies.

"Distressed" was a label coined by researchers, and should not be taken to mean that any company is bankrupt or in default on the basis of this calculation alone. Credit scoring is not fate, only prediction based on relative past performance of companies grouped by key variables. Time will tell.

Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.

Source: Dividends To Beat Rough Utility Stocks