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Nov 10, 2008
In a down economy, many money managers recommend that investors focus on dividend paying stocks. There are many attractive qualities to owning dividend paying stocks, some of which I've written about before. In a weak market, though, dividend paying stocks can be even more attractive. As stock prices fall, companies that can maintain or increase their dividend payout provide an increasing dividend yield to their stockholders. When you buy into a company that can sustain or even increase a high yield, you are effectively "locked in" to that high yield, which compounds every year, in addition to the likely capital gain of stock price appreciation.
It's important to note, though, that in this economy dividend cuts and eliminations are pretty common as companies get conservative with their cash. What can look like a can't miss opportunity for locking in a high dividend yield can vanish in a hurry when the press release announcing a dividend cut comes across the wire. It's important that investors make sure that the prospective company has a comfortable margin for paying out the dividend before making the investment.
To provide some ideas, I've looked over the Magic Formula screens used here at MagicDiligence (the top 100 stocks over 50 million market cap and the top 50 over 2 billion), looking for companies with solid yields of 3.4% or more and a dividend-to-earnings (payout) ratio of 45% or less. This should provide a list of solid dividend payers with enough margin of error to avoid having to cut the payout. Here are the results:
| Stock | Dividend Yield | Payout Ratio |
|---|---|---|
| Pacer International (PACR) | 5.70% | 30.1% |
| Meredith (MDP) | 4.70% | 31.9% |
| Rockwell Automation (ROK) | 4.50% | 27.9% |
| Emerson Electric (EMR) | 4.10% | 39.0% |
| HerbalLife (HLF) | 4.00% | 21.5% |
| American Eagle Outfitters (AEO) | 3.90% | 24.3% |
| Intel (INTC) | 3.80% | 40.7% |
| Northrup Grumman (NOC) | 3.60% | 30.2% |
| McGraw-Hill Companies (MHP) | 3.50% | 33.7% |
| Boeing (BA) | 3.40% | 30.9% |
| Innophos Holdings (IPHS) | 3.40% | 9.9% |
All of these companies look attractive on a dividend yield basis, and seem to have some margin of error to maintain their dividend payments. And, of course, since they are Magic Formula stocks, we expect them to be good companies as they generate high returns on invested capital. However, this should be taken as a starting point. The payout ratio is calculated against net earnings, which can occasionally contain one time gains and other non-repeatable factors. Also, you want to be sure that these companies have strong balance sheets and that their high return on capital is sustainable, even through down periods. These are things I examine and report on for MagicDiligence members.
Steve owns no position in any stocks discussed in this article.
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