Strong & Sustainable Dividends

By Arthur Pinkasovitch - January 22, 2012 | Tickers: AM, BPO, XLS, IP, RSH | 0 Comments

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Dividends can be paid out for a variety of basic reasons. Although the fundamental purpose of the distribution is generally to pass on company profits directly to the shareholders, several key motivations are behind such an action.

Firstly, dividend payments increase stock prices as the income stream becomes factored into the share price of a particular company either through the dividend growth model or simply through increasing investor sentiment. Secondly, dividends reflect the financial health of a firm; when corporations generate a steady cash flow beyond that required to sustain capital expenditures, extra cash can be passed on to the shareholders.

However, if the company is facing financial hardship, payments are ceased or decrease. Essentially, they serve as a signal mechanism to the market. Thirdly, dividends can also be used to hide the financial woes of a company -- this, unfortunately is very difficult to catch. A struggling company can raise equity or issue debt for the primary purpose of paying a dividend. Despite potential struggles, the market responds favorably to the dividend despite the fact that it is merely a transfer of funds from investor to investor rather than a payment that arose from strong operations.

Payout Ratio Explained

When selecting a dividend-paying stock, it is important to consider the payout ratio, a metric determined by taking the dividend per share and dividing that number by the earnings per share. A smaller ratio signals that based on the earnings generated by the company, the dividend payment is relatively small. In other words, a smaller payout ratio signals a scenario in which the dividend is sustainable. If, for example, this ratio is over 100%, more dividends are paid out than earnings are brought into the company. Therefore, although this can be the case for a quarter or two, such a system cannot proceed indefinitely. However, if, hypothetically, the payout ratio is 30%, the company has leeway to increase the dividend payout if the same level of earnings is realized in subsequent years.  

The Players

The following list of companies offers investors a significant yield of over 3% while maintaining a low payout ratio. These companies, thus, offer a healthy and -- more importantly -- sustainable dividend that will not likely get cut even if the economy retracts.

American Greetings' business operations are focused on designing, manufacturing and selling greeting cards on an international scale. Although not well researched by investors, American Greeting has been public since the late 1970s and currently offers investors a healthy 4.2% yield.

Brookfield Properties, the commercial and residential land development group, operates with a payout ratio of only 14%, meaning that its 3.2% dividend has the potential to be increased.

Perhaps not the most exciting business in the world, International Paper is an international paper and packaging company that has reached a $14 billion market cap. The company is very profitable and has a long dividend history dating back to 1987.

Although RadioShack’s stock performance has been on the decline in the last year, the consumer electronics retailer still offers solid fundamentals, which are accompanied by a 4.9% yield. Like International Paper, RadioShack has made distributions to shareholders since 1987.

Exelis operates in the high-paced, capital-heavy field of aerospace, defense and information and manages to generate significant cash flow and earnings, allowing the company to offer investors dividends. The low 19% ratio signals that this dividend is here to stay.

Conclusions

Investors should look beyond just the yield, but must factor in the yield along with the payout ratio. A dividend cut can often be detrimental to a firm’s stock price. Therefore, the risk of capital losses often outweighs the benefits of a high yield.

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