If something looks too good to be true, then it probably is.
Nowhere is this more true than in thestock market .
The late years of the 1990s were a great example of this.
Internetstocks with little to noearnings were burning up the
charts, pumping out huge gains and leading many investors to
believe that an early retirement was close at hand.
The housing boom of the early to mid-2000's also showcased this
dynamic. Everyone and their grandmother became an expert at
speculating inreal estate . The narrative on the Street was that
"housing prices never go down."
We all know exactly how both of those stories ended.
Investors jumping on the bandwagon looking for quick and easy
gains turned out to incur huge losses.
But now, a few years down the road, there is another kind
ofinvestment that is gainingcritical mass . With yields
onfixed-income assets hammered into the ground by the Federal
Reserve in the past four years,dividend stocks andfunds have are
now seeing huge capital inflows.
But greed is creeping into the dividend scene as well, with many
investors taking on abnormal amounts of risk reaching foryield
.
Take
Windstream Corp. (
WIN
)
. On the surface, the rural telecom's huge 10.4%dividend yield may
seem like a quick path to riches. But a closer look reveals big
risks. That's because the single most important factor when
evaluating the sustainability of a dividend is flashing bright-red
warning signals.
I am talking about thedividend payout ratio , a simple equation
that divides a company's annual dividend by its earnings. A reading
above 1 means a company is paying more in dividends than it is
actually earning, which is a big warning signal that the dividend
could be in jeopardy of being cut.
In the case of Windstream, its dividend payout ratio of 1.79
means the company is paying almost twice as much in dividends than
it earns. The higher yield has also been fueled byshares falling
15% in the past year, neutralizing any gain on yield with capital
losses.
Ideally, investors should look for a lowpayout ratio , leaving
plenty of financial flexibility for a company to sustain and grow
its dividend payments.
Here are eight companies on the S&P 500 with high yields and
low payout ratios, making them the most guarded and sustainable
dividends in the market.
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Out of the eight stocks listed, I like
Altria Group (
MO
)
because of itsinelastic demand profile and
Equity Residential (
EQR
)
because of itsleverage against a real estate recovery.
Altria Group
Altria Group manufactures and sells cigarettes, smokeless products
and wine worldwide and has amarket cap of $67 billion. With
consumer demand that is considered highly inelastic, Altria has
been in favor with investors in the past two years, lifting its
share price to a market-beating 38% gain.
But in spite of these gains, Altria still carries a hefty 5.3%
dividend yield, almost three times the 10-year Treasury yield of
1.8%. The company's payout ratio of 0.82 is also one of the lowest
for companies with dividend yields of more than 5%.
Equity Residential
Equity Residential is areal estate investment trust (REIT) that
buys, develops and manages multi-family properties in the United
States. Shares have seen huge gains in the past four years after
bottoming out in March of 2009, and then climbing more than
215%.
But with a dividend yield of 5.3%, Equity Residential still has
plenty tooffer investors hungry for a steady income stream. The
company's payout ratio of 0.51 is exceptionally low compared to
other high-yielding stocks but also to the overall market.
Risks to Consider:
Some analysts argue that a low payout is bad, because it's an
indication that the company is struggling to pay more to its
investors. I disagree, but this is another perspective for dividend
investors to consider.
Action to Take -->
A steady income stream from high-yielding stocks is what every
investor dreams. But while a high dividend payment is nice, it's
important to also measure the sustainability of a dividend
payment.
These eight stocks not only have high dividend yields of more
than 5%, but also low payout ratios that give them flexibility to
increase dividend payments. Out of the group, I particularly like
Altria Group because of its inelastic demand profile and Equity
Residential because of its leverage against a recovery in real
estate.