One of the things that is most alluring about dividends is that they are real hard cash. They simply can’t be faked and they can’t be taken back. That said, dividend payments can be cut or eliminated, if a financially weak dividend-paying company gets into trouble. This can happen for any number of reasons, but for an investor using dividend payments as a salary replacement the end result is a pay cut.
There are many ways to examine a company and attempt to determine its ability to continue paying dividends. One quick and easy method is to examine a company’s payout ratio. The payout ratio takes dividends and divides such payments by net income, essentially showing the percentage of earnings that is going to cover dividend payments. The lower the percentage the better, as it indicates that there are ample earnings to keep paying a dividend even if there are short-term financial strains that may temporarily depress a company’s bottom line. Although dividends are paid from cash flow, looking at how well dividends are covered by earnings, rather than cash flow, creates a stricter criterion that helps to identify some of the safest and best covered dividends.
To help identify stocks that income investors might find interesting for both their dividend yield and their dividend coverage, we used Value Line’s online screening tool to find companies with payout ratios below 33% and dividend yields above the average for the Value Line universe of approximately 1,700 stocks (currently 1.9%). A few companies that stand out include Whirlpool (WHR), Newell Rubbermaid (NWL), and Autoliv (ALV).
Subscribers can recreate this screen making it more or less as stringent as they wish. Note that some industries that are typically home to higher yielding stocks will never pass through this screen because of the nature of the industry. For example, real estate investment trusts (REITs) by law must pass through as dividends the vast majority of their earnings—for this industry a measure similar to cash flow (funds from operations, to be specific) is a more appropriate gauge of dividend paying ability. Utilities are another industry that isn’t likely to have material representation on this screen. Those caveats aside, this screen can help identify both strong companies and impressive dividends.
Autoliv is the world’s leading supplier of modules and components for passenger, driver-side, and side-impact airbag protection systems, seatbelts, steering wheels, safety electronics, whiplash protection systems, and child seats, as well as night vision systems, radar, and other active safety devices. Airbags and associated products accounted for 67% of the $7.2 billion in revenues earned during 2010, while seatbelts made up the rest. Autoliv’s primary customers include the world’s largest car manufacturers.
The company’s growth continues to outpace that of the broader auto industry, suggesting increased market share and safety device attach rates in emerging markets. However, there will likely be a few bumps in the road ahead as production disruptions in Japan reduce the need for Autoliv’s products over the near term. The company appears confident that this headwind will be remedied by the second half of 2012, as evidenced by its still-strong organic sales guidance.
Autoliv has raised its dividend in each of the past four reporting periods, and therefore, its payout ratio of 24% is towards the high end of this screen’s parameter. The stock’s 2.5% yield is above average, and based on recent earnings trends, we have confidence that the company will be able to cover its distributions for the foreseeable future.
Whirlpool Corporation sells laundry machines, refrigerators, cooking devices, dishwashers, mixers and other small household appliances primarily to retailers, distributors, and builders. The company markets products in nearly every country around the world. Although some brand names vary by region, the Whirlpool, Maytag, and KitchenAid lines are used everywhere. Lowe’s (LOW) is a major outlet for these brands and others, and was responsible for 10% of Whirlpool’s 2010 sales.
The company’s recent performance was better-than-expected, as demand in the United States held up nicely in the face of a weak housing market. The company’s reputation for durability, innovative product features and design, dependable performance, and energy efficiency has allowed its leading market share position to reach new highs of late. Whirlpool has been attempting to combat the impact of high raw materials costs by implementing a number of cost-containment efforts.
The company’s dividend has proven to be very stable over the past decade, and the issue’s current yield of 2.1% is respectable. The company’s payout ratio of 13% is among the lowest of our group. Indeed, we believe the Whirlpool’s healthy cash flow will ensure distributions continue to be paid when due.
Newell Rubbermaid, Inc.
Newell Rubbermaid produces consumer and commercial products marketed under brands like Rubbermaid, Sharpie, Paper Mate, Dymo, and several others. The company’s three business segments include Home & Family; Office Products; and Tools, Hardware & Commercial Products. A recent initiative dubbed “Brands That Matter” has made the product portfolio more innovative and differentiated, reducing its overall exposure to commoditized product categories. An expanding global footprint rounds out the plan.
Shares of Newell Rubbermaid came under pressure recently after 2011 earnings guidance was lowered due to retail softness and the negative effects of inclement weather. Management is taking efforts to combat this situation with price hikes. Although demand may remain poor in the near term, we think the company’s brand equity will allow it to effectively navigate the adverse economic conditions.
Dismal consumer spending during the recent economic downturn forced NWL to cut its dividend payment substantially. However, directors recently raised the payout 60%, and the yield is now above the Value Line median. We view this action as a sign of improved confidence in the company’s financial health and expect further dividend increases as the general economy improves.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.