Can Your Stock Afford Its Dividend?
When you seek income from your stocks, never forget that stock dividends are a discretionary outlay. Companies can raise the payment whenever they like — and they can reduce or eliminate it just as easily.
Most firms that pay dividends want to keep paying, and cuts generally come only when the companies feel the need to conserve cash. To assess whether a company has the means to keep up its discretionary spending — including the dividend — start by looking at how comfortably it can cover its obligations. Marketwide, large companies appear to have plenty of flexibility.
In the 12 months ended in March, the S&P 500 Index paid out 28% of its profits in dividends, well below the 20-year average of 37%. The index's interest coverage ratio — the sum of component companies' income before special items and interest expense, divided by interest expense — reached 5.6 in 2011, up from 1.8 in 2008 and the highest in at least 20 years. In addition, the index's components as a whole generated sufficient operating cash flow to pay their interest costs more than seven times over, also at least a 20-year high.
Why so much interest coverage? Credit historically low borrowing costs. Last year, the index's total interest expense ($176 billion) equated to just 2.7% of total debt, well below the average of 4.1% since 1993.
Total debt of $6.58 trillion at the end of 2011 was down from $10.46 trillion at the end of 2007 but up nearly 4% from 2001, when S&P 500 Index stocks carried debt of $6.34 trillion. In 2001, index components paid 62% more in interest than they paid last year.
Borrowing costs won't stay this low forever. In the table below, we present a list of 10 recommended stocks with the financial flexibility to continue paying a solid dividend and raising the payout over time, even after interest rates rise.
All of the stocks have interest coverage ratios higher than that of the S&P 500 Index. To weed out companies that keep their cash to themselves, we limited our screen to stocks with yields of at least 1% and that have boosted their payout in each of the last three years.