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In this series what we are aiming to do is provide a wealth of key ratios and then pick one of the plays as our favorite play. We will go on to provide some reason for this choice and in doing so, hope to impart some knowledge to those who are new to the field of dividend investing. A lot of ratios will be used in this article, and it would be best for investors to get a handle on some of these ratios, as they could prove to be very useful in the selection process. Some of the more important key ratios are listed below.

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 payout ratio over 100% indicates that the company is paying out more money to shareholders than 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. 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: Reasons To Be Bullish On Chevron Corp

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. For example, if a company has an interest ratio of 11.8, this means that it covers interest expenses 11.8 times with operating profits.

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

Quick ratio or acid test is obtained by adding cash and cash equivalents plus marketable securities and accounts receivable dividing them by current liabilities. It is a measure of a company's ability to use its quick assets (assets that can be sold of immediately at close to book value) to pay off its current liabilities immediately. A company with a quick ratio of less than 1 cannot pay back its current liabilities. Additional key metrics are addressed in this article Atlas Pipeline Partners A Great Long-Term Dividend play

We generally base our choice on the following factors:

  • Net income: it should be generally trending upwards for the past 3-4 years.
  • Total cash flow from operating activities: it also should be trending upwards for the past 3-4 years. Payout ratio= it should generally be below 100%, but a ratio below 70% is optimal. Payout ratios are not that important when it comes to MLPs/REITs as they generally pay a majority of their cash flow as distributions; in the case of REITs by law they have to pay out 90% of their cash flow as dividends. Payout ratios are calculated by dividing the dividend/distribution rate by the net income per share, and this is why the payout ratio for MLPs and REITs is often higher than 100%. The more important ratio to focus on is the cash flow per unit. If one focuses on the cash flow per unit, one will see that in most cases, it exceeds the distribution/dividend declared per unit/share.
  • Current ratio: should be above 1
  • Interest coverage ratio: any value above 1.5 is okay, but we would aim for 2.5-3.00 as our starting range. The higher the number the better
  • Dividend growth rate: it should be at 5% or higher. A high yield with a low dividend growth rate is not good in the long run, but neither is a low dividend yield with a high growth rate; one needs to find an equilibrium here.
  • Five year dividend average: we generally aim for stocks that have a yield of 4.5% or higher. There are exceptions to this rule. Some stocks appreciate very fast, so even though the yield might be low, one can more than make up the difference through capital gains. One example is JAH.
  • Sales: they should generally be trending upwards for the past 3-4 years.
  • Levered free cash flow: this is the icing on the cake; if a company meets most of the above requirements and also has a positive levered free cash flow; it can generally be viewed as a good long term buy. Two examples are LEG and PG.

An early warning signal that the company could be in trouble is when the total cash flow generated from operating expenses is not enough to meet the dividend payments. This information can be gleaned by looking at the cash flow statement; this is readily available at yahoo finance. In the example below we used LEG and the data was obtained from Yahoo Finance.

The cash flow in this case was more than enough to easily cover all the dividend payments for all the above years; in this the time period was from 2008-2010.

Many traders use other metrics and that is fine; we are just trying to provide a guideline. As you get better handle of the ratios explained below you can create your own list of criteria.

Stock

Dividend Yield (%)

Enterprise Value

Forward PE

EBITDA

Quarterly Revenue Growth

Beta

Revenue

Operating Cash flow

BlackRock Kelso Capital Corpora (NASDAQ:BKCC)

10.60

1.05B

9.21

N/A

43.70%

1.52

131.50M

-87.11M

Companhia Siderurgica Nacional (NYSE:SID)

6.70

21.16B

5.75

3.57B

7.40%

1.81

8.97B

1.64B

Kohlberg Capital Corporation (NASDAQ:KCAP)

10.10

220.60M

8.95

N/A

-10.30%

2.08

25.82M

89.50M

Seadrill Limited Ordinary Share (NYSE:SDRL)

8.30

28.00B

11.26

2.31B

-6.80%

2.00

4.10B

1.82B

Linn Energy, LLC (NASDAQ:LINE)

8.30

11.59B

15.94

1.15B

N/A

2.00

1.17B

518.71M

Important facts investors should be aware in regards to investing in MLPs

Payout ratios are not that important when it comes to MLPs, which generally pay a majority of their cash flow as distributions. Payout ratios are calculated by dividing the dividend/distribution rate by the net income per share, and this is why the payout ratio for MLPs is often higher than 100%. The more important ratio to focus on is the cash flow per unit. If one focuses on the cash flow per unit, one will see that in most cases, it exceeds the distribution declared per unit.

MLPs are not taxed like regular corporations because they pay out a large portion of their income to partners (as an investor you are basically a partner and are allocated units instead of shares) usually through quarterly distributions. The burden is thus shifted to the partners who are taxed at their ordinary income rates. As ordinary income tax rates of investors are typically lower than the income tax assessed on corporations, this arrangement is advantageous to the MLPs and generally most investors.

MLPs issue a Schedule K-1 to their investors. Unrelated business income (UBI) above $1,000 is taxable in an IRA. This information will appear Box 20 in the schedule K-1. UBI is typically a very small number usually well below $1000 and in some cases negative. If the MLP pays out distributions in excess of the income it generates, the distribution is classified as a "return of capital" and tax deferred until you sell your units. For more information, on this topic investors can visit the National Association of Publicly Traded Partnerships.

Our favourite play in this list is Linn Energy, LLC and we like it for the following reasons:

  • It has a 5-year dividend average of 9.50%
  • A very strong 5-year dividend growth rate of 18%
  • Linn Energy's distributions have more than doubled over the past six years.
  • Linn Energy's earnings have grown at an annual rate of 40% over the past five years.
  • It has an incredibly strong 3-year rate return of 248%
  • Net income and operating cash flow exploded upward in 2011.
  • Linn Energy's increased production by 30% in 2011 and has its eyes set on increasing production by another 40% in 2012. In the 4th quarter of 2011 productions rose by 38% to an average o 425 million cubic feet of gas equivalent per day. Part of this increase was the result of acquisitions; in December, it paid $600 million for oil and gas fields located in the Texas Panhandle and Oklahoma.
  • It sports a good current ratio of 1.4 and an acceptable interest coverage ratio of 2.5.
  • It also has a healthy levered free cash flow of almost $190 million.
  • It has grown from just a handful of wells (natural gas) in 2003 to one of the top 20 independent U.S. oil and natural-gas development companies with over 2.4TCFE in reserves.
  • In 2009 it delivered a 100% rate of return to unit holders.
  • It has interests in more than 9000 producing wells across the U.S. and huge list of inventory development opportunities that will maintain and increase production and reserves for years to come.
  • It has a decent current ratio of 1.45.
  • It sports a strong interest coverage ratio of 13.77.
  • The two main areas of growth for Linn Energy are the Permian Basin and its horizontal drilling program in the Granite Wash Trend. It holds over 70,000 gross acres in the Texas panhandle area alone and another 100,000 gross acres in the Oklahoma portion of the Granite Wash. It has already identified more than 100 drilling locations in the Texas Panhandle portion of the Granite Wash. Given the pace at which it is identifying new locations, we believe that its inventory will continue to grow over the years. What makes this area even more attractive is that many of the wells produce large amounts of condensate and NGL, which commands higher prices. This makes the Granite Wash one of the most economically attractive areas in the industry.
  • It also owns significant acreage in the north east sections of Oklahoma and Southern Kansas. Currently, this amounts to over 800,000 gross acres (400,000 net acres). It has identified more than 1000 high probability drilling locations. It also owns a stretch of land in the Mississippi Shelf play (260 miles long and 45 miles wide).
  • The Permian basin is Linn Energy's second largest operating area; this was achieved through aggressive acquisitions in 2010 and is going to be a very important driver of its future organic growth. It has roughly 400 proved oil- focused Permian Wolfberry drilling opportunities, and it holds 74MMBOe of proven reserves in the basin.
  • CEO Mark Ellis stated that Linn was looking at several acquisition opportunities, and that they have the cash and credit facilities to do this. This leads us to believe that 2012 will be another strong year in terms of acquisitions for Linn Energy
  • It sports a strong free cash flow yield of 17%.
  • It has a strong five year sales growth of 29.9%
  • 100K invested in Linn Energy would have grown to 245K in six years

BlackRock Kelso Capital Corp

Industry: Holding and other Investment Offices

Levered Free Cash Flow: 47.00M

Net income for the past three years

Net Income ($mil) 2009 = $67

Net Income ($mil) 2010 = $72

Net Income ($mil) 2011 = $77

Total cash flow from operating activities

2009 = $159.39 million

2010 = $37.84 million

2011 = $-87.1 million

Key Ratios

P/E Ratio = 9.3

Price to Sales = 5.47

Price to Book = 1.02

Price to Tangible Book = 1.03

Price to Cash Flow = 11.1

Price to Free Cash Flow = -4.4

Quick Ratio = 0.91

Current Ratio = N/A

LT Debt to Equity = 0.49

Total Debt to Equity = 0.49

Interest Coverage = 3.64

Inventory Turnover = N/A

Asset Turnover = 0.12

ROE = 10.32%

Return on Assets = 6.95%

Quarterly Earnings Growth = 191.8%

Dividend yield 5 year average = N/A%

Payout ratio = N/A

Dividend growth rate 3 year avg = -2.52%

Dividend growth rate 5 year avg = N/A%

Consecutive dividend increases = 0 years

Paying dividends since = 2007

Total return last 3 years = 386.76%

Total return last 5 years = N/A

Companhia Siderurgica Nacional

Industry: Non-Precious Metals

Levered Free Cash Flow : -1.40B

Net income for the past three years

Net Income ($mil) 2009 = $1320

Net Income ($mil) 2010 = $1437

Net Income ($mil) 2011 = $N/A

Total cash flow from operating activities

2008 = $2.07 billion

2009 = $-443.45 million

2010 = $1.5 billion

Key Ratios

P/E Ratio = 4.4

P/E High - Last 5 Yrs = 22.2

P/E Low - Last 5 Yrs = 2.3

Price to Sales = 1.68

Price to Book = 2.64

Price to Tangible Book = 3.41

Price to Cash Flow = 7.24

Price to Free Cash Flow = -8.3

Quick Ratio = 2.79

Current Ratio = 4.5

LT Debt to Equity = 3.05

Total Debt to Equity = 2.89

Interest Coverage = 3.6

Inventory Turnover = 2.04

Asset Turnover = 0.3

ROE = 39.1%

Return on Assets = 7.77%

Quarterly Earnings Growth = 51.6%

Dividend yield 5 year average = N/A%

Payout ratio = N/A

Dividend growth rate 3 year avg = -1.94%

Dividend growth rate 5 year avg = N/A%

Consecutive dividend increases = 2 years

Paying dividends since = 1994

Total return last 3 years = 81.44%

Total return last 5 years = 124.35%

Kohlberg Capital Corp

Industry: Holding and other Investment Offices

Levered Free Cash Flow: 52.64M

Net income for the past three years

Net Income ($mil) 2009 = $34

Net Income ($mil) 2010 = $-14

Net Income ($mil) 2011 = $N/A

Total cash flow from operating activities

2008 = $-6.58 million

2009 = $83.56 million

2010 = $199.87 million

Key Ratios

P/E Ratio = 88.9

P/E High - Last 5 Yrs = N.A.

P/E Low - Last 5 Yrs = N.A.

Price to Sales = 5.88

Price to Book = 0.86

Price to Tangible Book = 0.86

Price to Cash Flow = 13.47

Price to Free Cash Flow = 2.2

Quick Ratio = 14.36

Current Ratio = N/A

LT Debt to Equity = 0.32

Total Debt to Equity = 0.32

Interest Coverage = N/A

Inventory Turnover = N/A

Asset Turnover = 0.11

ROE = 8.93%

Return on Assets = 6.39%

Quarterly Earnings Growth = N/A

Dividend yield 5 year average = N/A%

Payout ratio = N/A

Dividend growth rate 3 year avg = -19.75%

Dividend growth rate 5 year avg = N/A%

Consecutive dividend increases = 0 years

Paying dividends since = 2007

Total return last 3 years = 576.98%

Total return last 5 years = -21.22%

Seadrill Ltd (SDRL)

Industry: Production & Extraction

Levered Free Cash Flow : -1.01B

Net income for the past three years

Net Income ($mil) 2009 = $1261

Net Income ($mil) 2010 = $1172

Net Income ($mil) 2011 = $1506

Key Ratios

P/E Ratio = 10.1

Price to Sales = 4.32

Price to Book = 2.87

Price to Tangible Book = 3.52

Price to Cash Flow = 9.17

Price to Free Cash Flow = -7.7

Quick Ratio = 0.73

Current Ratio = 0.80

LT Debt to Equity = 1.37

Total Debt to Equity = 1.36

Interest Coverage = N/A

Inventory Turnover = N/A

Asset Turnover = 0.23

ROE = 20.29%

Return on Assets = 7.42%

Payout ratio = 79%

Dividend growth rate 3 year avg = 162.31%

Dividend growth rate 5 year avg = N/A%

Consecutive dividend increases = 2 years

Paying dividends since = -1

Total return last 3 years = 574.85%

Total return last 5 years = 219.29%

Notes

Net income has increased nicely for the past few years, and it sports a very good 3 year dividend growth rate of 162%. Day rates are expected to trade north of $600,000 per day and this should prove to be very lucrative for SDRL.

Seadrill, the world's biggest offshore oil driller by market value, expects rig rates to keep rising for the next 12 months or longer, with daily tariffs for ultra-deepwater rigs rising above $600,000. The Oslo-listed company, which is valued at $18.3 billion and operates 44 rigs, has ordered several more ultra-deepwater rigs and expects to benefit from a booming market for oil exploration. Seadrill's modern fleet is in high demand after the BP oil spill as oil companies have put more emphasis on safety and drill for oil in more challenging environments.

Seadrill's chief financial officer, Esa Ikaheimonen, said Seadrill was bullish on rates and that the market was seeing almost everything up to 750,000 dollars plus per day.

Linn Energy LLC

Industry: Production & Extraction

Levered Free Cash Flow: 126.47M

Net income for the past three years

Net Income ($mil) 2009 = $-298

Net Income ($mil) 2010 = $-114

Net Income ($mil) 2011 = $438

Total cash flow from operating activities

2009 = $426.81 million

2010 = $270.92 million

2011 = $518.71 million

Key Ratios

P/E Ratio = 10.1

P/E High - Last 5 Yrs = N.A.

P/E Low - Last 5 Yrs = N.A.

Price to Sales = N/A

Price to Book = 1.96

Price to Tangible Book = 3.52

Price to Cash Flow = 10.03

Price to Free Cash Flow = -7.7

Quick Ratio = 1.26

Current Ratio = 1.45

LT Debt to Equity = 1.37

Total Debt to Equity = 1.17

Interest Coverage = 13.77

Inventory Turnover = N/A

Asset Turnover = N/A

ROE = 9.63%

Return on Assets = 4.46%

Quarterly Earnings Growth = N/A

Dividend yield 5 year average = N/A%

Payout ratio = N/A

Dividend growth rate 3 year avg = 2.73%

Dividend growth rate 5 year avg = N/A%

Consecutive dividend increases = 2 years

Paying dividends since = 2006

Total return last 3 years = 248.56%

Total return last 5 years = 51.99%

Conclusion

As the markets are extremely overbought it would make sense to wait for a pullback before committing large sums of money to this market.

EPS, Price, EPS surprise charts obtained from zacks.com. Free cash flow yield, income from continuing operations and revenue growth charts sourced from Ycharts.com. Earnings estimates and growth rate charts for sourced from dailyfinance.com. A major portion of the historical data used in this article as obtained from zacks.com. Consensus estimate analysis table sourced from reuters.com

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 Great Plays With Yields In Excess Of 10%