While high dividend yields (yield defined as dividend divided by stock price) are appealing, they become less so if they’re a function of a low stock price that reflects underlying financial weakness. In a recent Forbes article, Validea CEO John Reese says to look for those stocks that show higher-than-average yields along with a history of low dividend payout ratios and high dividend growth. He also offers the following warning signs when a dividend yield seems a little too good to be true:
- If the company is paying significantly higher dividends than its peers or paying a large percentage of earnings, this could be unsustainable and lead to future financial trouble.
- A decrease in earnings coupled with a rising dividend can signal heightened risk.
- Cash is required to pay dividends. If a company is cash-poor, it will be required to find liquidity quickly (which could cause financial strain).
- If dividend payouts are high, there is a lower likelihood that dividends can be raised down the road.
Reese identifies the following four companies that offer high dividend yields and receive strong scores from our guru-inspired investment models:
General Motors (GM) designs, builds and sells cars, trucks, crossovers and automobile parts through business segments across the globe. The company passes our James O’Shaughnessy stock screen with strong trailing 12-month sales ($153.9 billion) of more than 7 times the market mean and a dividend payout ratio of 21.9% compared to 45.2% for its peer group.
Dow Chemical (DOW) manufactures and supplies chemical, plastics and rubber products. Our Peter Lynch-based screen favors the company’s exceptional P/E/G ratio of 0.19. With a dividend yield of 3.61% (compared to 2.82% for its peer group) DOW stacks up nicely, particularly given its relatively low payout ratio of 34.2% (43.9% for peer group).
Coca-Cola Company (KO) licenses and markets more than 500 nonalcoholic beverage brands in segments across the globe. Our James O’Shaughnessy stock screen likes that this S&P 500 company’s sales are more than double the market mean and the dividend payout ratio of 80.7% is slightly lower than the group’s (83.5%).
Wal-Mart Stores (WMT) operates in retail, wholesale and other units in various formats around the world. The company’s cash flow-per-share of $7.87 and trailing 12-month sales of $483.2 billion both well exceed the market mean and satisfy our James’ O’Shaughnessy investment model. Dividend yield of 2.7% is slightly above its peer group (2.4%), while dividend payout of 43.6% is below the group (47.3%).