Investors have different approaches to stock dividends. Some have no interest in current income and would prefer companies to focus on growing their businesses, rather than distributing cash to shareholders. Others aren’t overly concerned about how high current dividend yields are, but would like to see dividends increasing steadily over the long term. Another group wants high income immediately, but also wants to avoid the risk of a dividend cut.
For those in the second group, we looked at the 30 companies in the Dow Jones Industrial Average
DJIA
in September, to identify which ones had increased dividends the most quickly over the past five years and 10 years. It turned out that the same four companies were the best dividend compounders for both periods.
This article is geared toward the last group — investors seeking high current income with a check for safety. A stock with a very high dividend yield has its own built-in warning. The high yield may reflect a recent decline in the share price as investors anticipated a dividend cut.
Mutual funds or exchange-traded funds provide diversification and lower risk for a fee, but some investors still want to hold individual stocks. For income seekers holding individual stocks, diversification among companies, sectors and industries can provide some protection from dividend cuts and the plunging share prices that precede or result from them.
There are never guarantees — we can screen stocks to try to identify those with high dividend yields that are expected to be well supported by cash flow. But before making any investment you should do your own research to form your own opinion about a company’s ability to remain competitive over the long term, while also supporting its dividend.
Digging into cash flow
One way to estimate a divided-paying company’s ability to maintain and hopefully raise its payout is to look at its estimated free cash flow yield.
Free cash flow (FCF) is remaining cash flow after capital expenditures. This money can be used to pay dividends, buy back shares (which can raise earnings and cash flow per share), to fund acquisitions, organic expansion or for other corporate purposes.
If we divide a company’s estimated annual FCF per share by its current share price, we have its estimated FCF yield. If we compare the FCF yield to the current dividend yield, we may see “headroom” for cash to be deployed in ways that can benefit shareholders. If a stock with a 5% dividend yield has an estimated FCF yield of 7%, it appears to have headroom of 2%. That might be a good enough cushion depending on a company’s industry and prospects, but we are more strict in the following stock screen.
Dividend stock screen for high yields well-backed by cash flow
For this screen, we started with the components of the S&P Composite 1500 Index
XX:SP1500,
which is made up of the S&P 500
SPX,
the S&P 400 Mid Cap Index
MID
and the S&P Small Cap 600 Index
SML.
We narrowed the list as follows:
-
Annual dividend yield of at least 5%, as calculated by FactSet, based on the companies’ four most recently declared quarterly payouts. This may not seem to be a very income level in an environment in which you can get a yield above 5% for a 12-month CD with no risk. The timing may be ideal to lock in that type of rate, because the Federal Reserve’s economic projections indicate three cuts to the federal-funds rate in 2024, in light of the declining U.S. inflation rate. The current target range for the federal-funds rate is 5.25% to 5.50%. On the other end of the yield curve, 10-year U.S. Treasury notes
BX:TMUBMUSD10Y
are yielding 3.87%, down from 4.84% two months ago. Investors have been pouring money into long-term Treasury securities to lock in higher rates, to set up gains when the Fed begins lowering interest rates, or both. - Coverage by at least five analysts working for brokerage firms polled by FactSet. This is to make sure we have a decent-sized sample of estimates underlying consensus estimates for 2024.
- Estimated free cash flow yield at least double the current dividend yield, based on consensus estimates for calendar 2024. In other words, the estimated headroom exceeds the current dividend yield. This should provide a margin of safety against the possibility of dividend cuts.
For most companies in the financial sector, especially banks and insurers, FCF information isn’t available. But in these heavily regulated industries, earnings per share can be a useful substitute to make similar headroom estimates. We also used EPS for real-estate investment trusts that engage mainly in mortgage lending.
For REITs that own property and rent it out (known as equity REITs), we can make similar use of funds from operations (FFO), a non-GAAP figure commonly used to gauge dividend-paying ability in the REIT industry. FFO adds depreciation and amortization back to earnings, while netting-out gains on the sale of property. This can be taken further with adjusted funds from operations (AFFO), which subtracts the estimated cost to maintain properties the REITs own and rent out.
When presenting the results of the screen, the “calculation method” column indicates which data fed the “FCF yield” column: FCF, EPS or AFFO.
Among the S&P 1500, 1,244 stocks are covered by at least five analysts polled by FactSet, with 99 of these having dividend yields of at least 5.00%.
Aside from financial companies with no FCF estimates available, for which we used EPS, and for equity REITs, for which we used AFFO, FCF estimates were unavailable for seven of the 99 remaining companies, which lowered the list to 91 stocks.
Among the 91, there were 11 companies meeting the criteria, with estimated headroom at least double the current dividend yield. Here they are, sorted by dividend yield — please see the notes below the table about Civitas Resources Inc.
CIVI,
| Company | Ticker | Dividend Yield | Estimated 2024 “FCF yield” | Estimated headroom | Calculation method |
| Uniti Group Inc. |
UNIT, |
10.79% | 26.52% | 15.72% | AFFO |
| Civitas Resources Inc. |
CIVI, |
10.69% | 22.08% | 11.39% | FCF |
| Organon & Co. |
OGN, |
7.93% | 32.13% | 24.20% | FCF |
| AT&T Inc. |
T, |
6.70% | 14.24% | 7.54% | FCF |
| Lincoln National Corp. |
LNC, |
6.59% | 26.09% | 19.49% | EPS |
| Whirlpool Corp. |
WHR, |
5.75% | 11.84% | 6.09% | FCF |
| Clearway Energy Inc. Class C |
CWEN, |
5.46% | 18.30% | 12.84% | FCF |
| Columbia Banking System Inc. |
COLB, |
5.34% | 11.53% | 6.19% | EPS |
| Comerica Inc. |
CMA, |
5.05% | 10.14% | 5.10% | EPS |
| Citizens Financial Group Inc. |
CFG, |
5.01% | 10.09% | 5.08% | EPS |
| Guess Inc. |
GES, |
5.01% | 11.23% | 6.22% | FCF |
| Source: FactSet | |||||
Click on the tickers for more about each company.
Click here for Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.
Civitas Resources pays a fixed quarterly dividend of 50 cents a share, plus a variable quarterly dividend, which most recently was $1.09, declared for the fourth quarter when the company announced its third-quarter results on Nov. 7. So the annualized regular dividend is two dollars a share, which would make for a regular dividend yield of 2.81%, based on the closing price of $71.09 on Dec. 26. The full fourth-quarter dividend of $1.59 would make for an annual payout of $6.36 — a dividend yield of 9.33%.
FactSet’s dividend yield of 10.69% for Civitas is based on the sum of the past four declared regular quarterly dividends of $2.00 and the past four declared special quarterly dividends of $5.60, for a total 2023 payout of $7.60. Paying a combined fixed plus special dividend is not uncommon among U.S. energy producers during this period of strong cash flow and an emphasis on prudent production and returning cash to shareholders.
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