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

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

However, 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 between spotting a winner or a dud.

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.

Long-term debt-to-equity ratio is the total long term debt divided by the total equity. The amount of long-term debt a company carries on its balances sheet is very important, because it indicates the amount of money a company owes that it doesn't expect to pay off in the next year. A balance sheet that illustrates that long term debt has been decreasing for a few years is a sign that the company is doing well. When debt levels fall, and cash levels increase, the balance sheet is said to be improving and vice versa. If a company has too much debt on its books, it could end up being overwhelmed with interest payments and risk having too little working capital which could, in the worst case scenario, lead to bankruptcy.

Cash ratio: This is the ratio of the company's total cash and cash equivalents to its current liabilities; this ratio is used a measure of a company's liquidity. It allows investors to determine how fast the company would be able to pay its short term debts if push came to shove. Higher numbers are better, because it makes it easier for a company to ask for new loans, increase in credit lines, etc.

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 some time. 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 5 Growth Plays: 4 Great And 1 Mediocre

Current Ratio is obtained by dividing the current assets by current liabilities. This ratio allows you to see if the company can pay its current debts without potentially jeopardizing their future earnings. Ideally, the company should have a ratio of 1 or higher.

Price to sales ratio is calculated by dividing the company's share price by its revenue per share. Generally, the smaller the ratio (less than 1.0) the better the investment, since the investor is paying less for each unit of sales. However, there are exceptions, as a company with a low price to sales ratio could be unprofitable.

Price to free cash flow is obtained by dividing the share price by free cash flow per share. Higher ratios are associated with more expensive companies and vice versa; lower ratios are generally more attractive. If a company generated $400 million in cash flow and then spent $100 million on capital expenditure, then its free flow is $300 million. If the share price is $100 and the free cash flow per share is $5, then company trades at 20 times free cash flow. This ratio is also useful, because it can be used as a comparison to the average within the industry; this gives you an idea of how the company you are interested in holds up to the other companies within the industry.

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 turnover 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. Additional key metrics are addressed in this article 5 Dividend Champs With Great Growth Potential

Century Link, Inc. (NYSE:CTL) is our favorite play on this list for the following reasons:

  • It sports good yield of 7.5%.
  • A five dividend average of 7.00%
  • A very strong five-year dividend growth rate of 75%
  • A very strong levered free cash flow of $2.68 billion
  • EBITDA has increased from $2.15 billion in 2009 to $6.04 billion in 2011.
  • Cash flow from operating activities has surged from $1.58 billion in 2009 to $4.21 billion in 2011.
  • Cash flow per share has increased from $5.70 per share to $8.43 per share.
  • It has a strong quarterly revenue growth rate of 170%
  • A 5 year sales growth of 7.4%
  • A five-year average payout ratio of 65%
  • A good three year total return of 90%
  • Gross profits have surged from $3.2 billion in 2009 to $9.02 billion in 2011.
  • A good free cash flow yield of 7.4%
  • 100K invested for 10 years would have grown to $150K.

Areas of concern

  • Net income has been dropping for the past three years, though operating cash flow has been surging and is more than enough to easily cover the dividend payments.
  • It sports a weak current and quick ratio, but an interest coverage ratio of 1.9 somewhat compensates for this.
  • Payout ratio is 127%, which is slightly worrisome, but operating cash flow is strong and more than enough to cover dividend payments.

Technical outlook

  • We would wait for a pullback to the 34.00-35.00 ranges before attempting to open new positions.

Century Link, Inc.

Industry: Services

Levered Free Cash Flow: 2.68B

Net income for the past three years

Net Income 2009 = $647 million

Net Income 2010 = $948 million

Net Income 2011 = $573 million

EBITDA 12/2011 = $6046 million

EBITDA 12/2010 = $3509 million

EBITDA 12/2009 = $2155 million

Net income Reported Quarterly = $109 million

Total cash flow from operating activities

2009 = $1.58 billion

2010 = $2.05 billion

2011 = $4.21 billion

Cash Flow 12/2011 = 8.43 $/share

Cash Flow 12/2010 = 8.12 $/share

Cash Flow 12/2009 = 5.7 $/share

Annual EPS before NRI 12/2011 = 2.21

Annual EPS before NRI 12/2010 = 3.39

Annual EPS before NRI 12/2009 = 3.6

Annual EPS before NRI 12/2008 = 3.37

Annual EPS before NRI 12/2007 = 3.16

ROE = 6.3%

Return on Assets = 2.46%

Quarterly Earnings Growth = -52.4%

Quarterly Revenue Growth = 170.2%

Key Ratios

Price to Sales = 1.59

Price to Book = 1.17

Price to Tangible Book = -6.11

Price to Cash Flow = 4.67

Price to Free Cash Flow = -24

Current Ratio 09/2011 = 0.88

Current Ratio 5 Year Average = 0.79

Quick Ratio = 0.88

Cash Ratio = 0.38

Interest Coverage = 1.90

Payout Ratio 09/2011 = 1.27

Payout Ratio 06/2011 = 1.16

Payout Ratio 5 Year Avg 09/2011 = 0.65

Payout Ratio 5 Year Avg 06/2011 = 0.59

Change in Payout Ratio = 0.62

Dividend yield 5 year average = 6.5%

Dividend growth rate 3 year avg = 1.18%

Dividend growth rate 5 year avg = 75.8%

Paying dividends since = 1974

Total return last 3 years = 91.63%

Total return last 5 years = 17.19%

FRONTIER COMMUNICATIONS CORP (NASDAQ:FTR)

Industry :

Levered Free Cash Flow: 701.40M

Net income for the past three years

Net Income 2009 = $121 million

Net Income 2010 = $153 million

Net Income 2011 = $150 million

EBITDA 12/2011 = $2314 million

EBITDA 12/2010 = $1686 million

EBITDA 12/2009 = $1048 million

Net income Reported Quarterly = $109 million

Total cash flow from operating activities

2009 = $742.72 million

2010 = $1.23 billion

2011 = $1.58 billion

Cash Flow 12/2011 = 1.65 $/share

Cash Flow 12/2010 = 1.14 $/share

Cash Flow 12/2009 = 2.08 $/share

Annual EPS before NRI 12/2011 = 0.24

Annual EPS before NRI 12/2010 = 0.37

Annual EPS before NRI 12/2009 = 0.55

Annual EPS before NRI 12/2008 = 0.58

Annual EPS before NRI 12/2007 = 0.67

ROE = 5.01%

Return on Assets = 1.37%

Quarterly Earnings Growth = -8.1%

Quarterly Revenue Growth = -5.6%

Key Ratios

Price to Sales = 0.84

Price to Book = 0.98

Price to Tangible Book = -1.14

Price to Cash Flow = 2.67

Price to Free Cash Flow = N.A.

Current Ratio 09/2011 = 1.07

Current Ratio 5 Year Average = 1.33

Quick Ratio = 1.07

Cash Ratio = 0.55

Interest Coverage 09/2011 = 1.4

Payout Ratio 09/2011 = 3.13

Payout Ratio 06/2011 = 3.41

Payout Ratio 5 Year Avg 09/2011 = 1.86

Payout Ratio 5 Year Avg 06/2011 = 1.78

Change in Payout Ratio = 1.26

Dividend yield 5 year average = 10.00

Dividend growth rate 3 year avg = -12.4%

Dividend growth rate 5 year avg = -5.12%

Consecutive dividend increases = 0 years

Paying dividends since = 2004

Total return last 3 years = 8.77%

Total return last 5 years = -38.68%

Notes

We would have to rate this as somewhat speculative, as management has let its shareholders down; they promised not to touch the dividend, but failed to deliver. It also needs to show that it can turn around the assets it purchased from Verizon, but most importantly, management will need to win shareholders trust back. Having said that the stock has taken a beating, and it looks like the worst news is priced in. A weekly close above 5 will change the outlook from neutral to bullish, and should result in a test of the 6.50-6.70 ranges. A monthly close above 6.00 should drive prices beyond 8. Even with the dividend cut it still offers one of the highest yields in the industry; current yield is 9.2%.

IDT Corp NYSE: (NYSE:IDT)

Industry: Services

Levered Free Cash Flow: 52.94M

Net income for the past three years

Net Income 2009 = $-155 million

Net Income 2010 = $20 million

Net Income 2011 = $27 million

EBITDA 12/2011 = $41 million

EBITDA 12/2010 = $66 million

EBITDA 12/2009 = $-28 million

Net income Reported Quarterly = $109 million

Total cash flow from operating activities

2009 = $-100.76 million

2010 = $56.21 million

2011 = $61.85 million

Cash Flow 12/2011 = 1.93 $/share

Cash Flow 12/2010 = 2.48 $/share

Cash Flow 12/2009 = -0.31 $/share

Annual EPS before NRI 12/2011 = 1.04

Annual EPS before NRI 12/2010 = 1.05

Annual EPS before NRI 12/2009 = -2.45

Annual EPS before NRI 12/2008 = -6.03

Annual EPS before NRI 12/2007 = -5.1

ROE = 8.1%

Return on Assets = 2.69%

Quarterly Revenue Growth = 21.6%

Key Ratios

Price to Sales = 0.14

Price to Book = 3.21

Price to Tangible Book = 4.22

Price to Cash Flow = 5.06

Price to Free Cash Flow = 58.6

Current Ratio 09/2011 = 0.92

Current Ratio 5 Year Average = 1.32

Quick Ratio = 1.34

Cash Ratio = 0.95

Payout Ratio 09/2011 = 1.42

Payout Ratio 06/2011 = 0.77

Dividend yield 5 year average = N/A%

Dividend growth rate 3 year avg = 0%

Dividend growth rate 5 year avg = N/A%

Consecutive dividend increases = 1 years

Paying dividends since = 2010

Total return last 3 years = 1666.24%

Total return last 5 years = -42.21%

Windstream Corp (NASDAQ:WIN)

Industry : Services

Levered Free Cash Flow: 245.20M

Net income for the past three years

Net Income 2009 = $399 million

Net Income 2010 = $313 million

Net Income 2011 = $172 million

EBITDA 12/2011 = $1728 million

EBITDA 12/2010 = $1724 million

EBITDA 12/2009 = $1598 million

Net income Reported Quarterly = $109 million

Total cash flow from operating activities

2009 = $1.11 billion

2010 = $1.1 billion

2011 = $1.23 billion

Cash Flow 12/2011 = 2.23 $/share

Cash Flow 12/2010 = 2.19 $/share

Cash Flow 12/2009 = 2.24 $/share

Annual EPS before NRI 12/2011 = 0.78

Annual EPS before NRI 12/2010 = 0.77

Annual EPS before NRI 12/2009 = 0.95

Annual EPS before NRI 12/2008 = 1.02

Annual EPS before NRI 12/2007 = 0.99

ROE = 39.75%

Return on Assets = 3.22%

Quarterly Revenue Growth = 23.5%

Key Ratios

Price to Sales = 1.66

Price to Book = 4.72

Price to Tangible Book = -1.29

Price to Cash Flow = 5.44

Price to Free Cash Flow = 412.9

Current Ratio 09/2011 = 1.04

Current Ratio 5 Year Average = 1.03

Quick Ratio = 0.99

Cash Ratio = 0.45

Interest Coverage 09/2011 = 0.83

Payout Ratio 09/2011 = 1.33

Payout Ratio 06/2011 = 1.33

Payout Ratio 5 Year Avg 09/2011 = 1.11

Payout Ratio 5 Year Avg 06/2011 = 1.09

Change in Payout Ratio = 0.23

Dividend yield 5 year average = 8.7

Dividend growth rate 3 year avg =

Dividend growth rate 5 year avg = -4.24

Paying dividends since = 2005

Total return last 3 years = 112.15%

Total return last 5 years = 23.12%

AT&T Inc NYSE : (NYSE:T)

Industry : Services

Levered Free Cash Flow: 3.22B

Net income for the past three years

Net Income 2009 = $12138 million

Net Income 2010 = $19864 million

Net Income 2011 = $3944 million

EBITDA 12/2011 = $31538 million

EBITDA 12/2010 = $40696 million

EBITDA 12/2009 = $41401 million

Net income Reported Quarterly = $109 million

Total cash flow from operating activities

2009 = $34.41 billion

2010 = $35 billion

2011 = $34.65 billion

Cash Flow 12/2011 = 5.8 $/share

Cash Flow 12/2010 = 5.59 $/share

Cash Flow 12/2009 = 5.42 $/share

Annual EPS before NRI 12/2011 = 2.2

Annual EPS before NRI 12/2010 = 2.29

Annual EPS before NRI 12/2009 = 2.11

Annual EPS before NRI 12/2008 = 2.81

Annual EPS before NRI 12/2007 = 2.77

ROE = 11.72%

Return on Assets = 4.81%

Quarterly Revenue Growth = 3.6%

Key Ratios

Price to Sales = 1.48

Price to Book = 1.77

Price to Tangible Book = -7.61

Price to Cash Flow = 5.45

Price to Free Cash Flow = 93.9

Current Ratio 09/2011 = 0.75

Current Ratio 5 Year Average = 0.65

Quick Ratio = 0.75

Cash Ratio = 0.31

Interest Coverage = 2.90

Payout Ratio 09/2011 = 0.78

Payout Ratio 06/2011 = 0.74

Payout Ratio 5 Year Avg 09/2011 = 0.66

Payout Ratio 5 Year Avg 06/2011 = 0.65

Change in Payout Ratio = 0.12

Dividend yield 5 year average = 5.8%

Dividend growth rate 3 year avg = 2.43%

Dividend growth rate 5 year avg = 5.10%

Consecutive dividend increases = 7 years

Paying dividends since = 1881

Total return last 3 years = 51.22%

Total return last 5 years = 6.75%

Notes

Net income has dropped dramatically in 2011; in 2010, net income stood at $19.81 billion and in 2011, it came in at $3.94 billion. It also sports a weak quick and current ratio, but it has a decent interest coverage ratio of 2.9 and a manageable payout ratio of 78%.

Conclusion

Long-term investors should wait for a strong pullback before committing new funds to this market.

EPS, EPS surprise, broker recommendations, and price and consensus charts sourced from zacks.com. Earning's estimates and growth rate charts sourced from dailyfinance.com. Free cash flow yield, income from cont operations, and revenue growth sourced from Ycharts.com. Dividend history 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 Communication Plays; 4 To Consider And 1 Speculative