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Safe Dividend Payers

Since no one can predict when the market will recover, pundits are advising buying dividend-paying stocks on the premise that you will be getting “paid to wait.” That’s good advice as long as you pick stocks that continue paying dividends at current levels. And that’s the rub.

Because the corporate and commercial real estate credit markets are still locked up, many firms with debt coming due this year are slashing their dividend payouts to conserve cash.

Here’s a strategy for finding stocks that won’t have that problem because they don’t owe anybody anything. Last week, I used Google’s new user-friendly stock screener to find five such no-debt, dividend-paying stocks. You can run your own screen (search) today. Here’s how.

From Google Finance (finance.google.com), click on the “stock screener” link. Google displays a default screening program using four of the 60 or so available criteria (selection choices). You’ll need the Market-Cap and Dividend Yield criteria. Delete the other two by clicking the “X” on the right of each criterion description. Click the “add criteria” link to see the menu of available search terms.

We’ll start with the most important, no-debt.

No Debt – No Problem
The debt/equity ratio, which compares debt to shareholders equity (assets minus liabilities), is the most widely used financial strength measure. A zero ratio indicates no debt, and the higher the ratio, the higher the debt. Because accounting rules require long-term lease obligations to be counted as debt, many nominally no-debt firms will have D/E ratios as high as 0.1 reflecting lease obligations.

Use the “total debt to equity ratio,” which compares the total of short- and long-term debt to shareholders equity and specify the most recent figure (recent quarter). We want to set the maximum allowable total D/E ratio at 0.1. However, Google throws us a curve here. Unlike all other sites, Google expresses as D/E as a percentage. So, to limit the D/E ratio to 0.1, on Google, you must specify a maximum 10 percent total debt/equity ratio (recent quarter).

Next, we’ll pinpoint no-debt firms paying significant dividends.

Dividend Yield 
Dividend yield is the return you’d receive on your initial investment from dividends over the next 12 months assuming that the dividend doesn’t change.

It’s calculated by dividing the next 12-months’ expected payouts by the price you pay for the shares. For example, the yield would be 10 percent if you paid $10 per share for a stock expected to pay dividends totaling $1 over the next year. We’re going to specify both minimum and maximum acceptable yields.

I set my minimum dividend yield at 3.5 percent, more than you can get from a bank these days. Since I arbitrarily picked that figure, try raising or lowering it to suit your needs.

Because yields go up when share prices drop, many stocks appear to be paying double-digit yields. Unfortunately, those high expected yields signal concerns that a dividend cut is on the way. Whether or not those fears turn out to be valid, double-digit expected yields signal high risk, the last thing we need is this market. Consequently, I set my maximum allowable dividend yield at 9.9 percent. 

On the topic of risk, we’ll add four more selection criteria to reduce risk.

Size Matters
Company size is an important risk factor. The bigger the company, the more likely that the firm has the product diversity, experience, and financial wherewithal to survive a tough economy.

Most experts use market capitalization, which is how much you’d have to shell out to buy all of the outstanding shares, to measure company size. Market-caps below $1 billion define small-caps, firms with market-caps above $10 billion are large caps, and those in-between are mid-caps.

To minimize risk, I rule out small-cap stocks by requiring a minimum $1 billion market-cap (specify minimum market-cap as 1B). 

Follow Smart Money
Because they generate huge trading commissions, mutual funds and other institutional buyers have better access to stock moving information than individual investors. Thus, if they don’t own a stock, you shouldn’t either. Institutional ownership, the percentage of a firm’s shares held by these big players, ranges from 40 percent to 95 percent for in-favor stocks. I specified a minimum 40 percent institutional ownership.

Not Too Cheap
Low trading prices signal stocks that are out-of-favor with most investors. Thus, although the market could get it wrong, low trading prices reflect high risk. For that reason, institutional investors typically avoid stocks trading below $15. However, given current conditions, I set my minimum allowable trading price (last price) at $10.

Profitability Rules
Profitability ratios measure how efficiently a firm uses its assets to generate earnings. The more profitable the company, the more cash it generates to grow its business. Return on equity (net income divided by shareholders equity) is the most widely followed profitability ratio. Many professional money managers avoid stocks with ROEs below 15 percent. Since this year has been a dud, I took a longer view and specified a minimum 15 percent five-year average return on equity.

Five Candidates
My screen turned up five stocks. Two, Analog Devices and Intel, are semiconductor chipmakers, however, they address different markets. Patterson-UTI Energy provides oil and natural gas drilling services, a beaten-down sector that isn’t going away. Paychex provides payroll services to small and mid-sized businesses and Zenith National Insurance offers workman’s compensation insurance.

As always, a simple screen can’t encompass everything that you need to know about a stock. So consider the results a list of research candidates, not a buy list.

published 1/4/09

 

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