Dow Jones MarketWatch, November 28, 2017 column: "Opinion: Here’s a better way to screen for dividend stocks so you don’t get burned" [Using primary source data to analyze a company's ability to maintain dividends]

Source: Dow Jones MarketWatch, November 28, 2017 column

Opinion: Here’s a better way to screen for dividend stocks so you don’t get burned

Published: Nov 28, 2017 4:06 a.m. ET

MARKETWATCH FRONT PAGE

A dividend cut is an income investor’s worst nightmare

Bloomberg News

Seagate Technology has reported plenty of free cash flow to support a higher dividend payout.

Philip

van Doorn

Investing columnist

As U.S. equity markets hit record highs, stocks with high dividend yields remain popular, despite the Federal Reserve’s inclination to raise official interest rates.

There are several ways to screen dividend-paying companies, and we’ll share two of them here, while listing the 35 highest-yielding stocks in the S&P 500 Index SPX.

Dreading dividend cuts

One of the riskiest aspects of dividend stocks is the prospect of a dividend cut. If investors expect the dividend to decline, the stock price is almost certain to plunge, which will push the yield higher until the cut is announced.

S&P Dow Jones Indices maintains a list of roughly 50 S&P 500 Dividend Aristocrats, which are companies included in that benchmark index that have increased their regular dividend payments for at least 25 consecutive years. However, many Dividend Aristocrat stocks have low yields.

Any analysis of a company’s financial performance is backward looking, so there can never be a guarantee that you won’t suffer a dividend cut. However, we can present data that will provide comfort or at least some warnings.

ROCC

Using data provided by FactSet, we looked at the 35 S&P 500 SPX stocks with the highest dividend yields. We’re going to list them twice (three times for real estate investment trusts).

First, we will show how the companies have performed against industry competitors, as measured by their returns on corporate capital (ROCC).

ROCC was recently developed by the Shareholder Forum. The calculation is similar to return on invested capital (ROIC), but there are some differences. Definitions of ROIC vary. ROCC is calculated the same way for every company that’s publicly traded in the U.S., using annual data filed with the Securities and Exchange Commission: Net income plus interest expense and income taxes, divided by the ending balance of total assets less total liabilities other than interest-bearing debt.

The idea is to measure how good a company’s management is at investing the money it raises or borrows. Each company’s ROCC is compared to its industry competitors, based on the company’s Standard Industrial Classification (SIC), which also comes from SEC filings. Those comparisons are available for free here.

So a company’s ROCC is not simply compared to the average ROCC for its SIC group. Instead, a calculation is made for the aggregated assets and income data for the entire SIC group, excluding for the subject company. This means that the industry ROCCs for two companies in the same group may be different.

ROCC is most meaningful within industries. Banks, for example, tend to have lower ROCC than many other industries because it is their business to leverage capital by gathering deposits and borrowing money.

You can get quite a bit of insight if you compare a company’s ROCC to its industry competitors. For example, the five-year ROCC trend for Altria Group Inc. MO is up, while the trend for its competitors in the cigarettes SIC group is down:

The Shareholder Forum

If the ROCC trend curve for a company you are interested in is heading south, something may be very wrong, and you had better do additional research to find out what is going on.

On Nov. 13, General Electric Co. GE said it would cut its dividend in half. That was not a surprise for investors, as company CEO John Flannery had said the dividend policy was under review as part of an effort to shore up cash.

Check out GE’s ROCC trend against that of its industry group:

The Shareholder Forum

The ROCC indicated that GE’s management just wasn’t getting it done.

Here are the 35 S&P 500 stocks with the highest yields, with five-year average ROCC comparisons and indications of whether the companies have cut their dividend payments at any time over the past five or 10 years:

Company	Ticker	Dividend yield - Nov. 24	SIC group	Average ROCC	Average ROCC for industry competitors	Dividend cut over past five years?	Dividend cut over past 10 years?
CenturyLink Inc.	CTL	15.61%	Telephone Communications (No Radio Telephone)	5.0%	7.3%	Yes	Yes
Macy’s Inc.	M	7.17%	Retail - Department Stores	15.3%	2.2%	No	Yes
Seagate Technology PLC	STX	6.25%	Computer Storage Devices	27.8%	9.9%	No	Yes
Kimco Realty Corp.	KIM	5.96%	Real Estate Investment Trusts	7.3%	3.9%	No	Yes
Scana Corp.	SCG	5.85%	Electric and Other Services Combined	7.4%	5.0%	No	No
Oneok Inc.	OKE	5.84%	Natural Gas Transmission and Distribution	5.7%	6.7%	No	No
Iron Mountain Inc.	IRM	5.67%	Real Estate Investment Trusts	7.6%	3.9%	No	No
AT&T Inc.	T	5.63%	Telephone Communications (No Radio Telephone)	7.4%	6.3%	No	No
HCP Inc.	HCP	5.51%	Real Estate Investment Trusts	7.7%	3.9%	Yes	Yes
Navient Corp.	NAVI	5.19%	Security Brokers, Dealers & Floatation Companies	1.1%	1.1%	No	No
Welltower Inc.	HCN	5.10%	Real Estate Investment Trusts	4.1%	4.0%	No	No
Verizon Communications Inc.	VZ	5.02%	Telephone Communications (No Radio Telephone)	8.9%	5.8%	No	No
Helmerich & Payne Inc.	HP	5.00%	Drilling Oil and Gas Wells	12.6%	1.5%	No	No
L Brands Inc.	LB	4.96%	Retail - Women’s Clothing Stores	33.4%	11.1%	No	No
Ford Motor Co.	F	4.96%	Motor Vehicles and Passenger Car Bodies	4.8%	0.6%	No	No
Kohl’s Corp.	KSS	4.88%	Retail - Department Stores	15.4%	3.6%	No	No
Ventas Inc.	VTR	4.79%	Real Estate Investment Trusts	5.4%	3.9%	Yes	Yes
Macerich Co.	MAC	4.61%	Real Estate Investment Trusts	7.6%	3.9%	No	Yes
Simon Property Group Inc.	SPG	4.53%	Real Estate Investment Trusts	8.1%	3.9%	No	Yes
Southern Co.	SO	4.51%	Electric Services	6.0%	4.8%	No	No
Realty Income Corp.	O	4.51%	Real Estate Investment Trusts	4.5%	4.0%	No	No
Occidental Petroleum Corp.	OXY	4.50%	Crude Petroleum & Natural Gas	1.3%	-5.8%	No	No
AES Corp.	AES	4.49%	Cogeneration Services and Small Power Producers	4.8%	N/A	No	No
Target Corp.	TGT	4.44%	Retail - Variety Stores	12.8%	18.4%	No	No
PPL Corp.	PPL	4.35%	Electric Services	7.1%	4.8%	No	No
Williams Cos.	WMB	4.28%	Natural Gas Transmission	4.6%	4.2%	Yes	Yes
FirstEnergy Corp.	FE	4.24%	Electric Services	-1.2%	5.2%	Yes	Yes
Entergy Corp.	ETR	4.17%	Electric Services	2.1%	5.0%	No	No
Philip Morris International Inc.	PM	4.15%	Cigarettes	50.1%	35.2%	No	No
Host Hotels & Resorts Inc.	HST	4.04%	Real Estate Investment Trusts	6.6%	3.9%	No	Yes
Altria Group Inc.	MO	4.03%	Cigarettes	36.2%	48.3%	No	Yes
Duke Energy Corp.	DUK	4.01%	Electric and Other Services Combined	4.3%	5.2%	No	No
International Business Machines Corp.	IBM	3.95%	Computer and Office Equipment	20.6%	4.0%	No	No
PG&E Corp.	PCG	3.92%	Electric and Other Services Combined	3.7%	5.2%	No	No
Interpublic Group of Cos.	IPG	3.84%	Services - Advertising Agencies	14.3%	13.0%	No	No
Sources: FactSet, Shareholder Forum

Note: We’re indicating whether a company has cut its dividend over the past five or 10 years. However, but this does not mean a company didn’t initiate a regular dividend payout during either of these periods.

CenturyLink CTL is the highest-yielding S&P 500 stock. A yield of 15.61% makes it very clear that many investors expect the company to cut its dividend. The company last cut its dividend on Feb. 13, 2013, when it announced a 26% reduction in the regular payout on the same day it unveiled a $2 billion buyback. That was quite a smack in the face for investors who were relying on the dividend income. The stock dropped 23% the following day.

During the company’s most recent earnings conference call with analysts on Nov. 8, CenturyLink CEO Glen Post said: “We realize the dividend is an attractive part of our shareholder return, and we are confident we can continue to pay the dividend while investing in growth and in our network and as we de-lever our balance sheet.”

A dividend cut that happened many years ago may not indicate that a company’s current payout is threatened. An example is Altria, which cut its dividend in 2008 after Kraft and Philip Morris International Inc. were spun off, so that shareholders of the former parent and spun-off companies would initially receive the same aggregate payouts.

A shorter-term approach: free cash flow yield

Leaving long-term performance aside, a company’s free cash flow yield can indicate whether it can comfortably continue to pay its current dividend or raise the dividend. Free cash flow is remaining cash flow after planned capital expenditures. It is money that can be used to raise the dividend, repurchase shares, expand through acquisitions, reinvest in plants and equipment, or do other things to grow the business organically.

We can calculate a company’s free cash flow yield by dividing its free cash flow per share over the past 12 months by the current share price. If we then compare the free cash flow yield to the current dividend yield, we can see if the company has “headroom” to increase the dividend.

If we look again at GE, we can see that as of the market close on Nov. 10, before the dividend cut was announced, the dividend yield was 4.69%. The company’s free cash flow yield over the previous 12 months was minus 1.27%. Its free cash flow per share was negative during three of the past four reported quarters.

If a company’s 12-month free cash flow yield is lower than its dividend yield, it does not necessarily mean a dividend cut is coming. The company may have made an important acquisition using a lot of cash, skewing the results for a year. Or there could be other good reasons for a temporary reduction in cash flow. But you had better find out.

For real estate investment trusts, a non-GAAP measure called funds from operations (FFO) is typically used by investors to gauge dividend-paying ability. FFO adds depreciation and amortization back to earnings, while subtracting gains on property sales. In the next table, we will show the same group of highest-yielding S&P 500 stocks with free cash flow yields based on GAAP. This will be followed by an FFO yield table for the REITs.

Here are free cash flow yield comparisons for the 35 highest-yielding S&P 500 stocks:

Company	Ticker	Dividend yield - Nov. 24	Free cash flow yield - past 12 reported months	‘Headroom’
CenturyLink Inc.	CTL	15.61%	6.16%	-9.45%
Macy’s Inc.	M	7.17%	21.34%	14.17%
Seagate Technology PLC	STX	6.25%	9.72%	3.47%
Kimco Realty Corp. (REIT)	KIM	5.96%	3.93%	-2.03%
Scana Corp.	SCG	5.85%	-2.61%	N/A
Oneok Inc.	OKE	5.84%	5.05%	-0.79%
Iron Mountain Inc. (REIT)	IRM	5.67%	2.85%	-2.82%
AT&T Inc.	T	5.63%	7.66%	2.03%
HCP Inc. (REIT)	HCP	5.51%	6.11%	0.60%
Navient Corp.	NAVI	5.19%	33.92%	28.73%
Welltower Inc. (REIT)	HCN	5.10%	3.00%	-2.10%
Verizon Communications Inc.	VZ	5.02%	2.79%	-2.23%
Helmerich & Payne Inc.	HP	5.00%	-0.67%	N/A
L Brands Inc.	LB	4.96%	6.06%	1.10%
Ford Motor Co.	F	4.96%	22.19%	17.23%
Kohl’s Corp.	KSS	4.88%	13.53%	8.65%
Ventas Inc. (REIT)	VTR	4.79%	6.02%	1.23%
Macerich Co. (REIT)	MAC	4.61%	4.96%	0.35%
Simon Property Group Inc. (REIT)	SPG	4.53%	6.60%	2.07%
Southern Co.	SO	4.51%	-3.30%	N/A
Realty Income Corp. (REIT)	O	4.51%	5.43%	0.92%
Occidental Petroleum Corp.	OXY	4.50%	2.25%	-2.25%
AES Corp.	AES	4.49%	3.23%	-1.26%
Target Corp.	TGT	4.44%	15.13%	10.69%
PPL Corp.	PPL	4.35%	-2.34%	N/A
Williams Cos.	WMB	4.28%	7.49%	3.21%
FirstEnergy Corp.	FE	4.24%	5.51%	1.27%
Entergy Corp.	ETR	4.17%	-8.57%	N/A
Philip Morris International Inc.	PM	4.15%	4.18%	0.03%
Host Hotels & Resorts Inc. (REIT)	HST	4.04%	6.34%	2.30%
Altria Group Inc.	MO	4.03%	3.38%	-0.65%
Duke Energy Corp.	DUK	4.01%	-3.67%	N/A
International Business Machines Corp.	IBM	3.95%	8.05%	4.10%
PG&E Corp.	PCG	3.92%	1.36%	-2.56%
Interpublic Group of Cos.	IPG	3.84%	2.88%	-0.96%
Sources: FactSet, Shareholder Forum

Note: For L Brands Inc. LB free cash flow figures for the quarter ended Oct. 28 are not yet available, so the free cash flow yield calculation is for the four quarters ended July 29.

Here are the REITs with FFO yield comparisons, as explained above the previous table:

Company	Ticker	Dividend yield - Nov. 24	FFO yield - past 12 reported months	‘Headroom’
Kimco Realty Corp.	KIM	5.96%	8.24%	2.28%
Iron Mountain Inc.	IRM	5.67%	5.02%	-0.65%
HCP Inc.	HCP	5.51%	7.66%	2.15%
Welltower Inc.	HCN	5.10%	6.28%	1.18%
Ventas Inc.	VTR	4.79%	6.43%	1.64%
Macerich Co.	MAC	4.61%	6.19%	1.58%
Simon Property Group Inc.	SPG	4.53%	6.73%	2.20%
Realty Income Corp.	O	4.51%	5.32%	0.81%
Host Hotels & Resorts Inc.	HST	4.04%	8.43%	4.39%
Sources: FactSet, Shareholder Forum

No screening method for stocks can be perfect. But long-term and short-term information, combined with your own research and opinion about a company’s products and business strategy, can help you pick solid stocks for income.

Philip

van Doorn

Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.