Scouring the market for excellent dividend stocks isn’t as easy as finding the stocks with the highest yields. In fact, dividend yield is just one of many factors investors should consider when they are looking for the best dividend stocks. To illustrate, I’ll analyze two companies whose stocks have meaningful dividend yields: Waste Management, Inc. (NYSE:WM) and Ford Motor Company (NYSE:F).
The essential marker of the best dividend stocks is an economic moat. Without a moat, forecasting future cash flow and dividends becomes unreliable. To determine whether a company has an economic moat, you’ll need to look for business advantages it has over its competitors, and then find some clear evidence to support your conclusion.
For instance, Waste Management, Inc. (NYSE:WM) constitutes the largest disposal business in North America. It boasts the largest network of recycling facilities, waste transfer stations, and landfills in the industry. Size like this usually implies that the company benefits from economies of scale. And, not surprisingly, the company’s unparalleled dominance in landfill ownership helps it achieve above-average return on equity, at 13%. Compare that to peers Republic Services and Waste Connections at 7% and 9%, respectively.
Our other example comes from the automotive industry, known for its highly competitive environment. In the trailing 12 months, Ford Motor Company (NYSE:F)’s sales were just 63% of Toyota Motor Corporation (ADR) (NYSE:TM)‘s, 91% of General Motors, and 53% of Volkswagen‘s. The auto industry is fragmented in such a way that there really is no obvious leader. Ford Motor Company (NYSE:F)’s market share in three important markets is representative evidence of the intense competition it’s facing: In the U.S., Europe, and China, Ford has about 17%, 8%, and 5% market share, respectively. Ford lacks an economic moat.
With nine years of consecutive dividend increases, Waste Management, Inc. (NYSE:WM) certainly has a formidable dividend history. But, as the company’s growth slows, the prospect of their dividend growth becomes less certain.
Ford Motor Company (NYSE:F) has a shorter history of dividend payments, having reinitiated its dividend just over a year ago. But a U.S. recovery has bolstered auto sales and helped the company more than double its 2012 dividend in 2013.
As Fool contributor Daniel Miller points out, Ford’s free cash flow levels are still far lower than they were about a decade ago, leaving plenty of room for further boosts to the dividend if free cash flow picks up.
The payout ratio is simply a company’s current dividend divided by its current level of earnings. The higher the ratio, the less sustainable the dividend if things go awry. The lower the ratio, the more room for potential dividend boosts in the future.