Dividend stocks are wildly popular these days. Most investors know that a bad bond market makes dividends attractive. However, very few know what really makes a good dividend stock.
The pay-out ratio, the percentage of a companies actual earnings that are paid out in dividends, is the key to successful dividend investing. Study after study has shown that high dividend payers with low pay-out ratios crush the markets’ returns.
In the spirit of crushing the market going forward I’ve compiled a list of top dividend payers. These stocks all have a low pay-out ratio, below 60%, and a dividend yield over 2%. Here’s the best of the best.
Industrial revolution
Since cutting its dividend in 2009, General Electric Company (NYSE:GE) has raised it six times in four short years. Today the dividend yield sits at 3.3% but, surprisingly, the pay-out ratio is still under 60%–earning it a spot on our list. General Electric Company (NYSE:GE) has always been known as a dividend stock. This fact is precisely why some investors shunned the conglomerate after the big dividend cut in 2009, but since then the company has executed well.
1). They’ve reduced the percentage of earnings that are dependent on their risky finance arm and non-core (i.e., NBC) businesses have been cut.
2). They’ve focused their resources on core industrial services
3). While they’ve raised their dividend six times, they’ve kept their pay-out ratio reasonable. This allows General Electric Company (NYSE:GE) to continue to re-invest in their business while also keeping their dividend safe.
Perhaps its near death collapse in 2008 taught General Electric Company (NYSE:GE) a thing or two. All I know is that GE’s dividend is much safer today, and so is the stock.
Apple Inc. (NASDAQ:AAPL) is not dead
Apple Inc. (NASDAQ:AAPL) is in transition right now. The company is changing from a hyper-growth stock to a more diversified play. The stock has surprisingly become a high yielder at 2.7%, a value play with a PE near 10, and it still has the ability to grow.
Often times investors don’t make the connection between earnings growth and dividends, but nothing could be more closely connected. For instance, Apple’s pay-out ratio is currently just under 30%, easily meeting our criteria, but if earnings grow it’ll become even lower. If that happens, Apple Inc. (NASDAQ:AAPL)will once again hear clamoring to raise its dividend. So, the chances are, if this company grows again you’ll likely see an increase in the stock price and the dividend. With iRadio set to launch, as well as new products and refresh cycles ahead, I think that growth is a reasonable bet.
Cisco: finally breaking through
IP-networking giant Cisco Systems, Inc. (NASDAQ:CSCO) has (finally) had a nice run up in its stock price. The stock is trading at a 52 week high, just over $24, after being range bound seemingly forever. Despite holding overwhelming market share, and showing consistent earnings growth, this company seems perpetually undervalued.
Some investors think that a PE around 12 isn’t too cheap for a company like Cisco but I disagree. Cisco is like Apple in a way, the market loves to discuss what it “isn’t anymore.” It should just be appreciated for what it is; it’s a wonderful producer of cash.
There’s a reason so many tech stocks pay high dividends with low pay-outs, they have remarkably consistent cash streams. Cisco easily meets our criteria with a pay-out ratio under 40% and a dividend yield of 2.8%. With a forward PE of just 11, growing earnings, and an industry leading CEO at the helm in John Chambers, I think a case can still be made for Cisco.
Deere season
I’m a huge fan of Deere & Company (NYSE:DE). Not only does it fit our criteria nicely, with a pay-out ratio under 25% and a dividend yield of 2.4%, the company has tremendous growth potential.
Deere is behind a major long-term growth trend in agriculture. As the population grows to 9 billion people by 2035–from a record 7 billion today–more people will need to be fed. Further, rough growing conditions due to overused land, and a coming refresh cycle in agriculture equipment, should drive growth going forward.
Yet, despite all that good news, the stock has been held in check with a PE just around 10. This is largely due to near-term weakness in crop prices and the broader commodity market; still, Deere has produced record results.
A very small portion of those earnings are being paid out in dividends right now. Deere’s dividends should continue to increase with earnings.
Why do dividend stocks with low pay-outs crush the market?
What’s the best part about these low pay-out stocks? How about not having to watch CNBC during every free moment of your life?
You won’t have to follow the constant rumors about when the Fed is going to stop its bond buying program. Dividend investors are worried about the Fed’s actions potentially raising bond rates. If that does happen the dividend bull could be toast; but not for low pay-out stocks.
The reason is simple. If the pay-out ratio is low, as long as earnings keep growing, there will be more cash available to increase dividend yields. It won’t matter what happens with the Fed or bond market.
Adem Tahiri owns shares of Apple and Deere & (NYSE:DE) Company. The Motley Fool recommends Apple and Cisco Systems (NASDAQ:CSCO). The Motley Fool owns shares of Apple and General Electric (NYSE:GE) Company.
The article 4 Dividend Stocks Built to Last originally appeared on Fool.com.
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