Top 5 Dividend Stocks - MRK, PFE, T, CVX, JNJ

Stocks that pay high and sustainable dividends are a boon to any income-seeking conservative investor. With the U.S. inflation rate at 2.3%, investors who do not exceed this yield in a year on their portfolio are actually losing money. Thus dividend stocks provide an income as well as long-term capital appreciation and should be an essential part of any conservative investor’s portfolio.

In searching for the top five yielding dividend stocks at the moment (end of May 2010), I used several parameters. First of all the company paying the dividend must be of sufficient size, in this case a market capitalization greater than $50 billion. Next, I wanted the dividend yield to exceed 3.5%. I did this because if or some reason the dividend the company pays declines slightly, there’s still a large cushion above the inflation rate. My next criteria was that the price to earnings ratio was lower than 20. I think 20 is a good point to start on the surface given that there are very few extremely high quality dividend payers that are selling for more than 20 times earnings. A lower PE ratio is also better on an absolute valuation perspective. After that, I demanded a Return on Equity greater than 10%. Companies that can pay high dividends and generate excellent return on capital simultaneously is a very healthy sign.

My final criterion was a price to cash flow between zero and twenty. I did this to eliminate all companies that did not generate positive cash flows from operating activities, and limited the search to those whose cash flows can be purchased relatively cheaply. Companies that do not generate positive cash flows will have problems paying dividends.

The top five dividend paying stocks, sorted by market capitalization and by these criteria are as follows:

In fifth place is Merck & Co. (MRK), a global health care company that delivers health solutions through its medicines, vaccines, biologic therapies, and consumer and animal products, which it markets directly and through its joint ventures. The U.S. based pharma company is currently yielding 4.51%. The risks for Merck are clear: patent expirations threaten a large portion of revenues and hence conservative investors should probably stay away.

Fourth is another pharma company, this time Pfizer (PFE). Pfizer is one of the world’s largest major drug companies and yields 4.73%. As in the case of Merck, however, Pfizer is facing some stiff headwinds going forward related to patent expirations. In saying that, both Pfizer and Merck score well on the metrics outlined above, which is really why their prices are being supported at these levels.

In third place is another high dividend payer well-known to all income seeking investors, and that’s AT&T (T). The US’s largest telecommunications company sits on a 6.91% yield. The risks to AT&T are clear too: competition and substitution amongst mobile operators is eroding margins. Fixed line is probably a thing of the past – or is it? Having met the criteria and sitting on a 6.91% yield, I’d go with AT&T (T) over Pfizer (PFE) or Merck (MRK).

Now for second place: and it’s Chevron Corporation (CVX). The oil and gas major is trading on a 3.9% dividend yield. Increased demand for oil from the world’s emerging economies such as China, Brazil, India and Russia is likely to cause price escalations. Supply is also constrained going forward as oil is getting more expensive to extract and refine. OPEC has also continually shown that oil at $70 per barrel is the floor with which they are looking to work. As such the dividend is safe and is probably likely to grow from here.

And finally, in first place is none other than Johnson & Johnson (JNJ), the word’s largest health and personal products company. The dividend yield is 3.71% at current prices. People in the US and around the world are getting older and living longer, and that gives rise to the potential for increased spend on health-related products. Johnson & Johnson is a great American company that has paid dividends for many years, and should be part of any serious long-term dividend-seeking investor’s portfolio.

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