Here's How to Find the Best Dividend Stocks

Markets Motley Fool

Finding a great dividend stock is about more than just finding the stock with the biggest yield. Sure, when dividends are your focus, the dividend yield is the most important metric. But there are a number of other factors to consider.

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For example, you might find a stock paying a great dividend today. But if the company isn't generating the free cash flow it needs to fund its dividend, it might be forced to cut its dividend tomorrow. (In which case, you'll be stuck owning a not-so-great dividend stock -- and probably one whose stock price is plummeting, as other investors flee the falling dividend).

Of course, if falling dividends are bad, then growing dividends must be good. In that case, you might also look into a dividend stock's payout ratio. This metric expresses, as a percentage, the dividends a company pays relative to the earnings it uses to pay them. A stock with a 100% payout ratio may be "maxed out" and financially incapable of growing its dividend. Conversely, a dividend stock with a payout ratio of 50% might still have room to grow its dividend over time.

Analyst projections for rising earnings are another indicator that over time, a stock that pays a good dividend today might pay an even better dividend tomorrow.

With these considerations in mind, I've drawn up a screen on free stock screening website finviz.com. I've instructed it to search for reasonably large, established companies ($2 billion in market cap and up) that:

  • Pay a respectable dividend (at least 3%);
  • Currently devote less than 70% of annual profits to dividend payouts;
  • Generate positive free cash flow; and
  • Are projected to continue earning, and keep growing earnings, over the next five years

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The following are three stocks that appear to fit the bill. Go ahead -- give them a look and see if you agree.

Intel

Our first stock to look at today is a name you'll be very familiar with: Intel (NASDAQ: INTC). The biggest name in computer chips worldwide, Intel is probably "inside" your laptop computer right now.

Priced at just 15 times earnings, Intel is so big that its fastest growth days are behind it. Still, analysts quoted on S&P Global Market Intelligence expect Intel to grow earnings at a respectable 7.5% annual rate over the next five years, helped by recent big acquisitions of companies like Altera (programmable chips that are particularly useful for building the Internet of Things) in 2015, and Mobileye (autonomous driving tech) earlier this year. Combined with a big 3.1% dividend yield (one full percentage point richer than the S&P 500 average), Intel's total return (dividends plus earnings growth) should average better than 10% annually over the next five years.

Cisco Systems

Math wizards will be quick to point out that Intel's anticipated 10.6% total return still only gives the stock a 1.4 total return ratio (P/E divided by the sum of dividends and earnings growth), which, while not exorbitant, still isn't particularly cheap. Can an investor do better?

Perhaps you can, by buying Cisco Systems (NASDAQ: CSCO) instead.

Still one of the biggest names in internet tech, Cisco has morphed into a slow-growth company as well, with analysts pegging the company for only 5.5% long-term growth. Cisco's richer dividend yield (3.7%) helps to make up for the slower growth. Plus, being less acquisitive than Intel of late, Cisco sports stronger financials. Whereas Intel's buying spree has left it with $6 billion more debt than cash on its balance sheet, Cisco today boasts cash and equivalents of $31.7 billion versus total debt of just $18.6 billion -- $13.1 billion more cash than debt.

Cisco also scores higher than Intel on quality of earnings. Over the past 12 months, Intel reported $12.7 billion in GAAP net income, but its actual free cash flow was only $11.8 billion. That is, for every $1 in "accounting profits" Intel reported, it generated cash profits of only $0.93. In contrast, Cisco's $12.9 billion in trailing free cash flow exceeded reported net income by 34%.

Translation: Cisco may look more expensive than Intel, but Cisco is cheaper than it looks.

Aegon N.V.

Switching gears from tech to life insurance, we now cross the Atlantic to visit Dutch life insurance giant Aegon N.V. (NYSE: AEG). Why make the trip? Because Aegon N.V. is one very cheap value stock -- and a rich dividend payer to boot.

With $1.9 billion in trailing net income, Aegon stock costs only 6.1 times trailing earnings, yet S&P data show the stock growing at 13% annually over the next five years. Even if that growth doesn't come in as strongly as expected, Aegon investors can rest easy. The company's 5.5% dividend yield is almost big enough to justify the stock's valuation -- with or without earnings growth.

Why is Aegon stock so cheap? Well, its return on equity isn't great at just 6.4%, which is subpar for a life insurer. (Rival Prudential scores 7.7% on this metric, while a good insurer like Lincoln National or Torchmark can earn an ROE as high as 9% to 11%). Then again, at a price-to-book value ratio of just 0.4, Aegon sells for a valuation half of what Lincoln or Torchmark costs.

I think that between its cheap price and rich dividend yield, Aegon just might be one of the best dividend stocks on the market today.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Cisco Systems and Intel. The Motley Fool has a disclosure policy.