The Safest Dividend in the S&P

In short, it's more important than ever to take a hard look at dividend safety before you invest for income. That's where I want to help.

To find the safest dividend in the S&P, I'm going to look at metrics like yield, earnings power, dividend coverage and track record. Let's see what we uncover.

Safety Criteria #1: Yield

When it comes to yield, it usually takes something above 6% to garner even a second look from me. So let's start with all the stocks within the S&P 500 that yield above that magic 6.0% number.

 

As I suspected, it turns out the common stocks in the S&P 500 don't offer much in the way of yields overall, but you can still find a few individual companies offering attractive payments.

In total, 18 stocks in the S&P (only 3.6% of the total) yield above 6.0%. Of those, the highest-yielding stock is Frontier Communications (NYSE: FTR), which pays investors 14.2% a year.

With these stocks in focus, I'll now turn to my next metric to uncover the safest dividend in the S&P: earnings power.

Safety Criteria #2: Earnings Power

It's not uncommon for "sick" stocks to carry high yields. Based on a poor outlook, investors will dump the shares, boosting the yield. To combat this potential pitfall, I'm looking at the 1-year growth in operating income (OI) for each of the 18 stocks with a yield above 6.0%.

Operating income is the profit realized from the company's day-to-day operations, excluding one-time events or special cases. This metric usually gives a better sense of a company's growth than earnings per share, which can be manipulated to show stronger results.

Given the downturn in the economy, I searched for companies on my high-yield list able to manage any growth in operating income over the last year, indicating the business was still able to thrive in one of the worst recessions in recent memory. After screening for positive 1-year growth in operating income, I'm left with the seven candidates shown in my table:

Safety Criteria #3: Dividend Coverage

No measure of dividend safety carries as much weight as the payout ratio. By comparing the amount of operating profit earned against how much is paid in dividends, we can know whether a company can continue paying its current yield, even if conditions worsen.

Safety Criteria #4: Proven Track Record

Looking into the track records of balance sheet of these five companies offers good news for investors -- each one has a solid history. Depending on what you look for in an investment, I'd consider any one of the five to be the safest dividend in the S&P 500.

For example, Altria has offered 5-year annual returns of +15.8% and throws off a 7.1% yield. Reynolds American is trading at a -25% discount to its average 5-year price-to-earnings ratio and has offered +10.0% annual returns since 2004. However, both are manufacturers of cigarettes and tobacco, which many investors choose to avoid.

Instead, Health Care REIT and HCP Inc. both have offered annual returns near the +10% range over the last five years and haven't had a dividend cut since they went public. These two REITS invest in healthcare properties, which may be a more palatable alternative to Altria and Reynolds.

The final stock I uncovered, DTE Energy (NYSE: DTE) operates electric and natural gas utilities in Michigan. Despite tough times in the state, the stock still manages to throw off 6.2% in dividends. You won't see much growth in the company's operations or dividend payments like you'll find with the other four candidates, but for a steady stream of income, DTE looks like a winning candidate.