The Three Best-Covered High-Yields in the S&P

Anthony Haddad's picture

Monday, September 14, 2009 - 7:26pm

by Anthony Haddad

Two dozen S&P 500 members yield 6% or more, about one in 20 companies listed on the market's benchmark.

Here are those companies:

Company Ticker Yield
Frontier Communications FTR 14.4%
Windstream Corp. WIN 11.1%
Century Telecom CTL 8.9%
Qwest Com Q 8.6%
Integrys Energy TEG 7.9%
Pepco Holdings POM 7.8%
Altria Group MO 7.5%
Reynolds American RAI 7.4%
Nisource NI 7.0%
Health Care REIT HCN 6.6%
HCP HCP 6.6%
Pinnacle West PNW 6.5%
Company Ticker Yield
Progress Energy PGN 6.4%
Duke Energy DUK 6.2%
Pitney Bowes PBI 6.2%
Cincinnati Financial CINF 6.2%
AT&T T 6.2%
Centerpoint Energy CNP 6.1%
Verizon Com. VZ 6.1%
Teco Energy TE 6.1%
Ameren AEE 6.0%
DTE Energy DTE 6.0%
Eli Lilly & Co. LLY 6.0%
Cons Edison ED 6.0%

But a high yield alone isn't enough, especially amid a year that has been rough on dividends. Dividend cuts in the first quarter outpaced dividend increases for the first time since 1955. The second time this happened? The second quarter of 2009.

While the overall economic situation still has room for improvement, 233 companies still increased their dividends in the second quarter. A great many companies simply let their dividends be, neither adding to them nor subtracting from them.

The trick is to find the companies with the strength to keep paying their shareholders. A few calculations will help us determine which companies are least likely to cut their dividends. Here are those calculations: What they are, how to do them, and, most importantly, which companies they reveal:

Cash Dividend Coverage Ratio
This metric a company's ability to meet its dividend obligations from its "cash flow," which is the money it earns doing business. To obtain the cash dividend coverage ratio, take the company's "cash flow from operations" (found on the cash-flow statement) and divide by the total dividends paid..

Any result below 1.0 is dangerous: It means the company is paying more in dividends than it's earning from its primary business. If the result is somewhere in the neighborhood of 2.0 you can consider the dividend "relatively safe." If the cash dividend coverage ratio is above 3.0, it's fair to call that dividend "very safe."

I'm not going to settle for "fairly safe" dividends. I removed any company whose ratio was less than 3.0. Seven companies made the cut:

Company Ticker Operating Cash Coverage Ratio
Nisource NI 6.2
Qwest Comm. Q 6.0
Verizon Comm. VZ 5.6
Ameren AEE 4.4
AT&T T 3.8
DTE Energy DTE 3.8
Pitney Bowles PBI 3.4

These companies look like they'll be able to pay their dividend easily. I like to double check this against another dividend-safety measure.

Free Cash Flow
"Free cash flow" is operating cash flow less what the company allocates to capital expenditures. Comparing free cash flow to dividends paid offers another look at dividend safety.

Three of the seven companies on the above list -- DTE, AEE, and NI -- have negative free cash flow. VZ paid more dividends than its free cash. While any of these situations can be corrected quickly, I'd wait until they are before I'd consider them as an ultra-safe dividend.

That leaves three companies:

Company Ticker Free Cash
Coverage Ratio
Qwest Comm. Q 2.5
Pitney Bowles PBI 2.5
AT&T T 1.3

These three companies offer an above-average dividend with best-in-class financial strength behind it. Serious income investors would be wise to consider any or all of these outstanding securities.

Anthony Haddad does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.