Buy These 5 Dividend Stocks With Rock Bottom Payout Ratios

Includes: AFL, CAT, DOV, TGT, V
by: Pey Shadzi

Back when I was in high school, I was one of the few kids who actually picked up a job for side money at the age of 16. I grew up in a rather well-to-do area of Northern California, and for some reason, my parents were the only adults in our town that felt the need to teach their children about the power of financial responsibility. As far as I know, none of my other friends ever even considered a job until after college.

As it turns out, I worked at a local juice bar just down the road from my house. One thing that was abnormal about this business was the fact my boss would always cut our paychecks on Tuesday, but request we refrain from cashing the checks until the following Tuesday. Looking back, I thought it was a bit weird, but now that I am older, I realize this was an obvious sign of desperation from a struggling food service business. Luckily, I was a high school student without any real financial responsibilities. Had I needed the money, I just might have been in a bit of trouble.

Perhaps that's why nowadays I look to invest in dividend-paying companies with strong cash flows and sufficient cash on hand to cover any disbursements provided each and every quarter. Maybe my first job taught me enough about the inability to share profits, and this ingrained in me a strong desire to avoid this in my adult life with investments.

Few dividend investors would argue that choosing companies with solid, consistent dividend-paying policies and adequate cash flows to cover these payouts is a bad thing. It may not allow you to find companies with enormous dividend yields, but for us younger investors out there in the accumulation phase looking for dividend growth, at least it provides a bit of safety and a relatively strong promise for the future.

Here are five dividend-payers I particularly like with extremely modest payout ratios:

1. Target Corp. (NYSE:TGT): Target is one of those amazing Dividend Aristocrats that has been rewarding shareholders for many, many decades. TGT is a Minnesota-based company with a market cap of $41 billion, a forward P/E of 12.9, a PEG ratio of 1.3, a 2.3% current dividend yield and a 27% payout ratio. In June 2012, Target raised its dividend by 20% and has plans to aggressively continue to raise payouts over the next few years. I recommend reinvesting dividends while looking for opportunities to jump in when the stock dips below $60 a share.

2. Caterpillar Inc. (NYSE:CAT): CAT is an Illinois-based company with a market cap of $57 billion, a forward P/E of 8.3, a PEG ratio of 0.51, a 2.4% dividend yield and a 21% payout ratio. With a beta of 1.8, the stock shows quite a bit more volatility, but I suppose this presents more compelling reasons to buy the stock when hovering near annual lows, like when it dipped below $70 a share late last year. It stands to reason that Caterpillar will benefit from a reviving economy, and I believe many investors are looking forward to the day when the recent recession is a thing of the past. CAT's P/E ratio hasn't been as low as current values in over three years, while revenue continues to climb. Perhaps these are compelling reasons to take a closer look at shares of CAT.

3. Visa Inc (NYSE:V): Visa is a San Francisco-based company that needs no introduction. V has a market cap of $87 billion, a forward P/E of 18.3, a PEG ratio of 1.1, a 0.7% dividend yield and a 15% payout ratio. With such a low percentage of free cash flow going toward the dividend, it's safe to say this company will continue to reward long term stock holders for many years to come. I've long waited for a significant pullback so I could buy shares at a more reasonable price, but this just hasn't materialized lately. I am willing to buy on any dips, though it's unlikely I'll be able to pick up shares in the $70 range as I did a few years back. I truly believe V's long-term potential is incredible, which may be why investors are willing to pay 18.3 times forward earnings for this well-known company.

4. Dover Corporation (NYSE:DOV): DOV is a less well-known Illinois-based industrial manufacturing company with a market cap of $10 billion, a forward P/E of 10.5, a PEG ratio of 1.21, a 2.3% dividend yield and a 27% payout ratio. DOV is another one of those stocks with an extremely low dividend payout ratio that could easily be doubled while still comfortably meeting free cash flow. Being a cyclical stock, this is one that may not produce steady, consistent returns, but could very well produce stellar returns for the patient investor. I love picking up shares of DOV when it dips into the low $50s.

5. Aflac Incorporated (NYSE:AFL): AFL is a Georgia-based company with a market cap of $30 billion, a forward P/E of 6.6, a PEG ratio of 0.61, a 3% dividend yield and a 24% payout ratio. I still have no idea why AFL was trading in the low $40 range a few months back. I've been picking up shares every chance I get, and I believe this stock is staging a massive run up for the near future. Shares looked incredibly tempting at $40 a share, but do not necessarily look overvalued at the current price of $45 and change a share.

The bottom line

Dividend-paying stocks are considered a necessary component to building wealth in dividend growth portfolios. Choosing stocks with extremely low payout ratios doesn't necessarily guarantee better returns over the long run, but for younger investors who still have time and patience to accumulate shares while reinvesting dividends and hopefully taking advantage of capital appreciation, it's definitely not a bad idea to include a few of these companies in a portfolio.

Many comparisons can be made when evaluating an employer who has enough cash flow and assets in the bank to pay its employees and choosing dividend-paying corporations with low payout ratios to ensure future dividend payment checks. Just like my high school employer who couldn't guarantee our paychecks would clear, finding companies that have overextended themselves may prove to be detrimental in the long run.

Do yourself a favor and take a good look at a company's payout ratio when evaluating dividend-paying stocks. It may provide a few insights as to future cash dividend payments and a company's ability to continue to reward shareholders into the distant future.

Now if you'll excuse me, I'm going to whip up a smoothie at my home here in San Diego. I guess financial literacy wasn't the only thing I learned at that juice bar, am I right?

Disclosure: I am long V, DOV, AFL, TGT.