10 Stocks That Can Sustain Their Dividends

by: Scott's Investments

This article is the second this week which focuses on stocks in DRIP Investing's Dividend Champions list, which is updated monthly at dripinvesting.org. The Dividend Champions are stocks which have raised dividends each year for at least 25 consecutive years.

One important metric in an analysis of dividend paying stocks is the payout ratio. The payout ratio of a stock is the percentage of earnings paid to shareholders as dividends. The higher the percentage, the more earnings are being paid out to shareholders in the form of dividends.

Long-term dividend investors should look for stocks which have a sustainable payout ratio and allow some margin for error if the company has short-term difficulty growing earnings. Stocks paying out a relatively low percentage of its earnings as dividends have a higher probability of sustaining its dividend, which, for income investors, is critical in any investment decision.

While seeking low payout ratios might make intuitive sense, how has it actually performed over time? One study I cite frequently showed that from 1990-2006 stocks with low payout ratios performed better than those with high payout ratios and stocks with the highest dividend yield and lowest payout ratio performed the best.

By combining dividend stocks that have a lengthy history of increasing dividends with a highly sustainable payout ratios, we can maximize our potential for long-term success in an equity income strategy. The Dividend Champion list provides us with a starting point of stocks with a lengthy history of paying and increasing dividends. Starting with this list, I then ranked the ten stocks on the list with the lowest payout ratios. The 10 lowest payout ratios according to DRIP Investing as of 10/29/10 are below:

Company Symbol Trend Industry Yrs Payout Ratio % as of 10/29/10
Energen Corp. (NYSE:EGN) Here Utility-Gas 28 13.47
Franklin Resources (NYSE:BEN) Here Financial Services 29 13.99
C.R. Bard Inc. (NYSE:BCR) Here Medical Instruments 39 14.6
Stepan Company (NYSE:SCL) Here Cleaning Products 43 17.51
H.B. Fuller Company (NYSE:FUL) Here Chemical-Specialty 41 18.92
Archer Daniels Midland (NYSE:ADM) Here Farm Products 35 20
Questar Corp. (NYSE:STR) Here Utility-Gas 31 20
Sigma-Aldrich Corp. (NASDAQ:SIAL) Here Chemical-Specialty 34 20.58
Helmerich & Payne Inc. (NYSE:HP) Here Oil & Gas 38 20.69
RLI Corp. (NYSE:RLI) Here Insurance 35

*Wesco Financial (NASDAQ:WSC) was excluded from the list because they are scheduled to become acquired.

For those seeking yield, only one stock on the list yields more than 2%, STR at 3.18%. RLI just dropped below 2% this week due to share price appreciation and currently yields 1.95%. By comparison, the Utilities SPDR ETF (NYSEARCA:XLU) yields 3.95%. So STR is yielding less than the ETF representing its sector.

What is an investor to do in this case? When looking for the lowest payout ratio stocks with long histories of paying dividends, the current market does not yield many results for those seeking stocks paying more than 10 year Treasuries. Use multiple strategies to create a basket of stocks, ETFs, and other investment products.

Combine a low payout ratio strategy like the one featured here with a high yield, high momentum strategy like the one I wrote about on Sunday (STR appears on both lists).

Use other dividend lists such as the S&P Dividend Aristocrats and screen for additional fundamental factors until you find 10-20 dividend stocks worthy of your portfolio. I will also be highlighting the highest momentum, highest yielding stocks on the Dividend Champions list in coming days which will generate additional ideas.

Finallly, understand that as a general rule the higher the yield, the higher the risk. There is no such thing as a free lunch...

Disclosure: None