A high dividend yield can signal that a company’s shares are a bargain or that trouble is looming. The job of the value investor is to tell the former case from the latter.
There’s no way to know for sure. Affordability measures, like the cost of the dividend divided by the amount of free cash flow, are no guarantee because healthy companies sometimes cut payments to afford acquisitions. However, by using such measures, investors can at least put the odds in their favor. There are other signs that dividends are safe, too. Recent sales growth is a sign that more prosperous days lie ahead, and a recent dividend increase beats management say-so as a judge of a company’s commitment to payments. Below are three companies with affordable-looking 5% yields and recent dividend and sales increases.
Verizon Wireless (VZ) - Dividend yield: 6.1%
Apple (AAPL) plans to produce an iPhone this year that could allow Verizon (VZ) and others to end AT&T’s (T) service monopoly for the gadget, The Wall Street Journal reported last week, citing anonymous sources briefed by the company. Expect Verizon to prosper either way. An iPhone partnership would bring a jump in sales, but only a stingy increase in profits, because carrier subsidies for the phone are the highest in the business and Apple doesn’t share its application sales with carriers. For the moment, Verizon enjoys wider profit margins than competitors, and free cash flow should swell this year as the company winds down spending on FiOS, its fiber-optic competitor to cable television.
Eli Lilly (LLY) - Dividend Yield: 5.4%
Like most of the big drugmakers, Eli Lilly (LLY) faces upcoming patent expirations. But as Jeffrey Holford of Jefferies and Company wrote to clients last month upon initiating coverage of the stock with a buy recommendation, Lilly is the “cheapest patent/cliff recovery play in the sector.” Shares trade at less than eight times this year’s earnings forecast, and the company has little debt, plenty of cash flow and a handful of promising drugs in its pipeline
Consolidated Edison (ED) - Dividend yield: 5.3%
Consolidated Edison (ED) transmits and delivers power to New York City and surrounding areas and has a rate structure that makes its returns highly predictable if slow-growing. Regulators recently agreed to allow the company to raise its rates by 12.6% over three years, which is less than management had asked for, but shares have nonetheless climbed since. The city’s jumble of wires and pipes is well more than a century old and provides ConEd with constant opportunities for investment, which the company in turn can use to bolster its appeals for rate hikes. Even assuming the stock price goes nowhere, the dividend yield reinvested is enough to double an investor’s money in a little over 13 years.
Disclosure: The Div Guy owns shares of VZ and T at the time of this post.