With the sharp declines in the stock market, we now see attractive dividend yields all around.
But while dividend yields rise as stock prices fall, be careful trolling for rich dividend plays. Many of them will blow up in your face.
That’s because cash flows are drying up because of the coronavirus pandemic, which puts financial stress on companies. Many will be cutting dividends to compensate. If you are shopping for dividends, you don’t want one of these turkeys.
To sort the good from the bad, I consulted a half-dozen dividend experts to point us to the safe dividend plays.
Here are 26 companies with safe dividends, and also some lessons from these experts on how to make this call if you want to look on your own.
Go for ‘asset-light’ businesses
Companies that don’t have to put a lot of money into factories and equipment typically have lots of cash flow. This is a good place to look for dividend durability.
Two companies that have safe dividends here are the money management company BlackRock US:BLK with a 3.3% yield, and the market exchange operator CME US:CME (1.8%), says Matthew Page of the Guinness Atkinson Dividend Builder fund US:GAINX.
He’s worth listening to because his fund beats its MSCI ACWI index and Morningstar world large stock category by an annualized 2.3 and 2.8 percentage points, respectively, over the past three years, says Morningstar.
One quality he likes to see when weighing dividend safety is a high interest coverage ratio, or EBITDA divided by interest costs. This should be around eight or more. He also likes to see relatively low dividend payouts relative to earnings. Dividend payouts should be around 50% or less. BlackRock has virtually no debt, so interest coverage isn’t an issue, and it has an acceptable dividend payout ratio of 54%. CME has an interest coverage ratio of 15 and a payout ratio of 40%.
Consider banks and insurers
These financial-sector plays have been hammered for obvious reasons. Banks have to deal with bad loans, and insurers have a tough time getting return on investment because interest rates are low. To find the safer names in this space, Kelley Wright, of Investment Quality Trends, looks for low dividend payout ratios of around 50% or less, reasonable long-term debt to equity ratios of around 50% or less, and a long history of dividend hikes of 10 years or more, among other qualities.
Shop in the worst-hit sector
The Energy Select Sector SPDR US:XLE, Vanguard Energy US:VDE and SPDR S&P Oil & Gas Exploration & Production US:XOP exchange-traded funds are down 47% to 55% so far this year through Thursday, compared to 14% and 17% for the S&P 500 US:SPX and the Dow Jones Industrial Average US:DJIA .
This means energy stocks are sporting some of the highest dividend yields. But shopping for yield in this group is especially tricky because so many energy companies are in financial trouble or even destined for bankruptcy.
Among energy producers, JPMorgan energy analyst Christyan Malek thinks Total US:TOT FR:FP (8.2% yield), Equinor US:EQNR NO:EQNR (8%) and Galp Energia US:GLPEY PT:GALP (3.9%) have enough balance sheet headroom to avoid dividend cuts. They’re also well positioned for the energy “supercycle” ahead. Because producers are cutting back so much on investment now, supply shortages as the economy strengthens over the next two years will spark a dramatic spike in oil prices, he predicts.
For help navigating the energy services sector minefield, I turned to Goldman Sachs. It recently published an impressively thorough analysis of the companies that provide rigs and equipment to energy producers. Goldman Sachs has slashed earnings estimates in this group by 40%, so you can see the potential for dividend cuts and bankruptcies.
To avoid problem names, Angie Sedita and her team at Goldman Sachs suggest focusing on these qualities. Look for lots of international exposure, because U.S. producers will be cutting spending by 35%-40% compared to 10%-15% at foreign producers. Look for strong balance sheets, defined in part as ones with debt to total capital of less than 50%, and an EBITDA to interest expense multiple of at least eight times.
Companies that are reaffirming or raising their dividends
Few companies are so righteous about dividends. But McDonald’s US:MCD (2.8% yield), Starbucks US:SBUX (2.2%), and Caterpillar US:CAT (3.6%) have all reaffirmed their payouts with less fanfare. Others are actually hiking dividends, a pretty sure sign they won’t be cutting them soon. Procter & Gamble US:PG (2.5%) and Johnson & Johnson US:JNJ (2.7%) are examples.
A grab bag of industry stalwarts
Goldman Sachs analyst Alex Meintel recently screened for companies with an earnings payout ratio of 66% or less, and low leverage (net debt to EBITDA below two times), after eliminating those where Goldman analysts are skeptical about dividend stability. Names with higher yields on this short list include: American International Group US:AIG (5.5% yield), Verizon US:VZ (4.3% yield), United Parcel Service US:UPS (4%), Caterpillar (3.6%), Johnson & Johnson (2.7%), Lockheed Martin US:LMT (2.5%) and Target US:TGT (2.4%).
Go with chemicals
Morgan Stanley strategist Adam Virgadamo recently hunted for companies at low risk for cutting dividends even if things get as bad as in the financial crisis. Three chemical companies came up with low risk for dividend cuts: Eastman Chemical US:EMN which pays a 5% yield, LyondellBasell Industries US:LYB (8%), and Linde US:LIN (2.1%).
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested BLK, CME, BKR, NOV, MCD, SBUX, CAT, PG, JNJ, VZ, LMT, EMN and LYB in his stock newsletter Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School.
Originally Published on MarketWatch
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