The Highest-Yielding Dividends That Are Safe to Hold

May 31, 2014 by Jon C. Ogg

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Dividend payments by S&P 500 companies reached an all-time high last year, totaling some $330.8 billion, according to FactSet. As of this March, 418 of the 500 companies in the index paid a dividend.

However, not all dividends are created equal. Of the 500 companies in the index, 96 pay their shareholders a dividend of 3% or more. As a rough comparison, a 10-year Treasury note yields close to 2.5%. While Treasury securities come with a virtual guarantee of a return of principal, share price appreciation is generally expected to provide higher returns. Dividends are intended to make those returns even better over time.

Dividends are considered among the most straightforward ways for a company to reward investors. After all, they represent a direct transfer of cash from the company back to its shareholders. However, a high dividend yield alone does not give a complete picture of the value of an investment. The financial health and business prospects of the company has to be considered as well. Investors need to be able to differentiate a high dividend from a safe dividend.

Some companies, like Chevron, can easily afford to offer investors a 3.5% dividend yield. While this is among the higher yields in the S&P 500, Chevron likely has the means to pay even more, since it is among the most profitable companies in the United States.

Surprisingly, some companies pay dividends even when they lose money. For example, Windstream Holdings, with a 10.4% dividend yield, actually pays out three times its trailing 12-month earnings in dividends. However, such a combination of high payouts and unprofitability is not sustainable.

To identify the highest-yielding S&P 500 stocks that are safe for investors, 24/7 Wall St. reviewed the companies that are currently paying dividends of 3% or more. While the three companies with the highest dividend yields in the S&P 500 are in the communications sector, none of them satisfied all of our screen criteria.

We excluded any company with a market capitalization of less than $10 billion. We also eliminated companies that we believe cannot afford to maintain their dividends or for which a net loss is expected. Many of the dividends and earnings figures are based on forward-looking analyst estimates.

We generally put a limit on the income payout rate at 80%, meaning that companies must retain 20% of their expected earnings this year and next year for other uses, such as share buybacks and growth opportunities. This excluded the real estate investment trusts (REITs), which pay out almost all income to maintain their special tax structures.

In some instances, companies do elect to cut dividends, even when the market does not expect it. This happened to one company that we previously thought offered a safe dividend, FirstEnergy. The company cut its dividend by a third last year, a decision many followers attributed to the unregulated energy sales part of its business.

Companies involved in transformative mergers or acquisitions were excluded if the combination could potentially place the dividend at risk. We did make an exception for AT&T, which acquired DirecTV. We independently determined at the time of the deal’s announcement that it was unlikely that AT&T’s dividend would be affected by the transaction. We also only included only two utility companies, which typically pay very high dividends, since this would have otherwise skewed our results largely towards that sector.

These are the highest-yielding dividends that are safe to hold.

1. AT&T
> Dividend yield: 5.2%
> Annualized dividend: $1.84
> Share price: $35.49
> P/E ratio: 13.2

AT&T Inc. (NYSE: T) is one of the nation’s leading telecommunications companies. It is the highest yielding stock in the Dow Jones Industrial Average, with a dividend yield of 5.2%. AT&T recently agreed to acquire satellite television provider DirecTV for $48.5 billion. While this may seem like a large amount, the company had more than $18 billion in earnings last year alone. Many of AT&T’s businesses are cash cows, allowing the company to spend roughly $21 billion in cash last year on capital expenditures, while paying nearly $10 billion in dividends and spending more than $13 billion on share buybacks.

2. Southern Company
> Dividend yield: 4.9%
> Annualized dividend: $2.10
> Share price: $43.74
> P/E ratio: 15.7

Southern Company (NYSE: SO), based in Atlanta, is a utilities holding company operating in four southeastern states. It currently has a 4.9% dividend yield and a market cap of $38.9 billion, based on a share price of $43.74 as of May 30. Southern Company has a track record of consistently growing its dividend, which now pays out $2.10 on an annualized basis. Recently, the company has experienced delays and cost overruns in the construction of its Kemper County, Miss., coal facility. This, along with other issues, prompted investment bank UBS to issue a Sell rating on the stock. The Kemper plant is designed to produce energy from coal in a more environmentally friendly manner by implementing carbon capture and storage technology. Despite the cost, Moody’s maintained the company’s credit rating for its senior unsecured debt at an investment grade Baa1 with a stable outlook.

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3. Consolidated Edison
> Dividend yield: 4.6%
> Annualized dividend: $2.52
> Share price: $54.94
> P/E ratio: 14.7

ConEd is a utility company supplying electricity and gas to much of New York City and nearby Westchester County. Because ConEd is a regulated utility, it has to gain approval from the state to increase charges to customers for parts of their monthly bills. The company’s most recent efforts to increase rates were rejected by the state. Despite this, the company has long been considered relatively safe and stable. It currently offers a dividend yield of 4.6%. Consolidated Edison Inc. (NYSE: ED) also has a payout ratio of only about 67%, which is very safe for a utility.

4. Altria
> Dividend yield: 4.7%
> Annualized dividend: $1.92
> Share price: $41.46
> P/E ratio: 16.1

Altria Group Inc. (NYSE: MO) is one of the largest tobacco companies in the world, with a market capitalization of $82.5 billion. Currently, the company’s shares trade at $41.56, with a dividend yield of 4.7%. The company has been operating in a shrinking industry as national adult smoking rates have declined for decades, from 42.4% in 1965 to just 19% in 2011, according to the most recent data from the Centers for Disease Control and Prevention. Its closest competitor, Reynolds American, was excluded from the list this year despite offering a 4.6% dividend yield. This was largely because Reynolds is said to be in talks to acquire rival Lorillard. Until a deal is reached, it is not possible to determine what the company’s combined balance sheet would look like.

5. Chevron
> Dividend yield: 3.5%
> Annualized dividend: $4.28
> Share price: $122.65
> P/E ratio: 11.4

Chevron Corp. (NYSE: CVX) is one of the nation’s largest energy companies with operations throughout the globe. Chevron reported more than $220 billion in operating revenue last year, with earnings exceeding $21 billion, and cash from operations surpassing $35 billion. Its dividend payments totaled $7.5 billion. The highly profitable company has benefited from a growing U.S. energy industry. With the rise of unconventional drilling, the company has announced plans to expand its production in Texas’s oil-rich Permian shale, and it is also active in Pennsylvania’s Marcellus shale, which is a major source of natural gas. The dividend yield of Chevron shares is currently 3.5%, and it looks as though Chevron has the means to keep increasing its dividend for years.

6. Kraft Foods
> Dividend yield: 3.6%
> Annualized dividend: $2.10
> Share price: $58.99
> P/E ratio: 18.5

Shares of Kraft Foods Group Inc. (NASDAQ: KRFT) — owner of well-known American brands such as Jell-O, Kool-Aid, and Planters — currently yield 3.6%. According to Morningstar, the average dividend yield among Kraft’s peers is far lower at 2.2%. The company earned $2.7 billion and paid $1.2 billion in dividends last year. Unlike many other companies with high-yielding and reliable dividends, Kraft Foods is technically a very young company. It was formed in 2012 when Kraft Foods split its grocery business from its snack food operations, now called Mondelez International.

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7. Procter & Gamble
> Dividend yield: 3.2%
> Annualized dividend: $2.57
> Share price: $80.69
> P/E ratio: 19.2

Procter & Gamble Co. (NYSE: PG) provides consumer packaged goods through a variety of consumer-facing retail outlets such as drugstores and grocery chains. The company has increased its annual dividend each year in the past 58 years. P&G returned $12.5 billion to shareholders last year. With both dividends and share repurchases, shareholders received 110% of the company’s earnings in 2013. Its dividend payout ratio is only about 61% for 2014. However, the company has struggled with less than stellar sales growth and slumping returns in recent years, and it brought back former CEO A.G. Lafley last year to help boost growth. Currently, the company’s shares yield 3.2%. P&G currently has a massive $220 billion market cap, which dominates its peer group.

8. Intel
> Dividend yield: 3.3%
> Annualized dividend: $0.90
> Share price: $27.10
> P/E ratio: 14.3

Intel Corp. (NASDAQ: INTC) has been criticized for missing the emergence of the smartphone and tablet markets, where it currently holds a small market share relative to rivals NVIDIA and Qualcomm. Intel CEO Brian Krzanich has stated the company hopes to have its chips in 40 million tablets by year-end. As a result of its struggles, Intel investors have had to deal with several years of lower revenue and shrinking margins. Still, the company remains a major player in the PC market, and it generated $9.6 billion in profits last year. The company’s $2.4 billion share buyback was offset by the shares issued to employees under various compensation and incentive plans. Intel still pays less than half of its earnings per share as dividends.

9. Eli Lilly
> Dividend yield: 3.3%
> Annualized dividend: $1.96
> Share price: $59.69
> P/E ratio: 21.5

Currently, Eli Lilly and Co. (NYSE: LLY) shares change hands at $59.86, up roughly 11% from a year ago but still nowhere near all-time highs set at the beginning of the previous decade. Additionally, revenue growth over the past three years was considerably lower than most other pharmaceutical companies, according to Morningstar. Among the problems the pharmaceutical giant faced have been the expiration of a number of key drug patents in recent years. Eli Lilly has not increased its annual dividend of $1.96 per share since 2009. In late 2013, Eli Lilly’s management outlined steps to maintain its dividend payout while simultaneously announcing a $5 billion share buyback plan.

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10. Lockheed Martin
> Dividend yield: 3.3%
> Annualized dividend: $5.32
> Share price: $163.13
> P/E ratio: 14.9

Lockheed Martin’s stock price skyrocketed from $91.34 at the end of 2012 to $163.13 as of May 30. Despite this run up, Lockheed Martin Corp. (NYSE: LMT) still carries Buy recommendations from numerous ratings firms. The company earned $2.87 per share in its most recent quarter, exceeding Wall Street’s expectations and its reported earnings from a year ago. As the world’s largest defense contracting company, with $36 billion in arms sales as of 2012 according to the Stockholm International Peace Research Institute, perhaps it is no surprise Lockheed Martin stock is high yielding and relatively safe. The company’s market cap is more than $52 billion.