It has one of the highest yields in the S&P 500 [Read this article on our website.]( [Smart Money Monday]  Apr 18, 2022 How to Pick Dividend-Payers, Plus My Favorite One to Buy Now Thompsonâs Note: Inflation has reached a 40-year high, the war in Europe is dragging on, lockdowns in China are pinching already stressed supply chains⦠Regular readers know Iâm not a macro guyâIâm a bottoms-up stock picker. But I still follow macro trends, and I can see the market stressors piling up. Which means SIC 2022 couldnât be coming at a better time. We have an unparalleled roster of top-notch strategists lined up to guide you through the turmoil. And Iâll be there sharing more about how I find profitable opportunities in any environment, as well as answering your questions on the final day of the event. If you havenât reserved your Virtual Pass to the SIC 2022 yet, take a moment and [click here](. Now, letâs run through how to pick the best dividend-paying stocks, and look at my favorite one to buy now⦠*** Ask income investors what theyâre looking for, and one word is bound to come up⦠Predictability. Income investors want to know the money will keep showing up. We all know stock prices fluctuate up and down. After all, nothing goes up in a straight line. But for strong dividend-paying companies, one thing remains constant: the cash they pay shareholders in the form of dividends. This might sound obvious, but a company can only continue to pay dividends if it generates earnings. And it can only grow its dividend if it grows those earnings. With that in mind, hereâs what I look for in a dividend-paying stock⦠- First, look at cash flow, not earnings. Traditional financial wisdom suggests using the âdividend coverage ratioâ to evaluate if a company can continue to pay its dividends. Itâs a simple ratio: earnings per share/dividends per share. Meaning a company earning $1/share that pays a $0.25/share dividend can cover its dividend four times over. Itâs a reasonable metric. However, those earnings come from the companyâs income statement. And they often donât accurately reflect the cash moving in and out of the business. So, I look at something different. When Iâm evaluating a companyâs dividend, I open its âstatement of cash flows.â Then Iâll pinpoint its free cash flow (operating cash flow, less capital expenditures). And then Iâll scroll down a bit on the same statement and find âdividends to shareholders.â - Rule of thumb: If free cash flow is greater than dividends to shareholders, youâre in good shape. Consumer goods juggernaut Proctor & Gamble (PG) is a solid example here. P&G has generated a significant amount of cash flow after dividends over the past 5 years. Free cash flow has grown from $9 billion to $15 billion, while the dividend has grown from $7 billion to $8.2 billion. Meaning itâs had plenty of cash to cover its dividend. -  The second factor I look at is the strength of the balance sheet. If free cash flow is less than the dividend, the company is getting the money to pay that dividend somewhere . And most of the time, itâs from borrowing money. Take oil major Exxon (XOM), for example. In 2020, it got itself into a precarious situation. Its free cash flow couldnât cover its dividend to shareholders. The company managed to preserve the dividend, but not without taking on more debt. Its total debt rose 44% from $46 billion to $67 billion that year. That is not a good sign. A strong dividend payer can maintain its financial strength while paying out its dividends from free cash flow. So, check the balance sheet to see if the company is increasing debt to cover its dividend. - The third factor I consider is the quality of the business model. A shrinking company is going to have trouble maintaining its dividend. Take a company like Meredith Corp. (MDP), which sells print magazines and owns TV stations. Meredith was a strong dividend payer for years. But those are tricky marketsâprint magazines are dying off, and consumers are cutting the cord on cable TV. COVID exacerbated Meredithâs problems, and it wound up cutting its dividend during the pandemic. - My favorite dividend-paying stock checks all three boxes⦠In January, I shared three of my top picks for the year. One of them was AT&T (T). My editor begged me not to write about it [when I first recommended it]( in Smart Money Monday . And I got the same feedback this go-around. âItâs too big, Thompson. You write about small caps.â Sure, itâs not like the high-growth small caps I recommend in High Conviction Investor , but I still like AT&T a lot here. As you may have heard, AT&T just finalized the spinoff of its Warner Media business and merged it with Discovery Communications. AT&T shareholders received 24 shares of the new company, Warner Bros. Discovery (WBD), for every 100 shares of AT&T they owned. AT&Tâs dividend is in great shape. The new company has a $1.11 per share dividend. On todayâs price, that implies a 5.8% yieldâone of the highest yields in the S&P 500. The company has set a policy of paying out 40â45% of free cash flow as a dividend. Thatâs a very healthy coverage ratio. It also gives AT&T flexibility to pay down debt if it chooses. Historically, AT&Tâs dividend has equaled 50â65% of free cash flow. So, this new policy is much more conservative. Over time, it can return to slowly growing the dividend alongside earnings. And from an industry perspective, cell phones arenât going anywhere, so weâre in good shape there. AT&T checks all the boxes for a strong dividend-paying stock. Consider buying shares if you havenât already. Thanks for reading, [Thompson Clark] âThompson Clark
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[90% of equity returns over the last 50 years have come from this investing strategy...]( [Thompson Clark]Thompson Clark is a small-cap expert and value-focused investor with nearly a decade of experience in financial publishing. Thompson graduated from the Goizueta Business School at Emory University in 2010 with a focus in finance and accounting. He lives in North Carolina. He is the editor of Mauldin Economicsâ free research service, [Smart Money Monday]( . Don't let friends miss this timely insightâ
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