3 Stocks With Reliable 3% Dividends

A 3% dividend yield is all well and good, but how can an investor be sure management will continue making the payments? They can’t be certain, but there are plenty of clues, some more telling than others.

To judge a dividend’s affordability, some investors compare the dollar amount of payments with some measure of how much money a company makes, like earnings or free cash flow. That’s a good start, but it has shortcomings. Earnings aren’t quite the same as real cash coming in. Free cash flow is, but it can swing wildly from one year to the next. Also, low payout ratios aren’t necessarily a promising sign. A 2003 study published in Financial Analysts Journal showed to the surprise of many (or at least, to the surprise of many finance nerds) that high payout ratios tend to predict faster earnings growth. And anyhow, sometimes companies with perfectly affordable payments cut them to fund acquisitions and such.

Investors can look for a long history of rising payments, but that can be misleading, too. No U.S. companies have more impressive dividend records than the S&P 500 Dividend Aristocrats, which have increased payments each year for at least 25 years. We began this year with 55 Aristocrats, but have now lost eight to dividend cuts. Sometimes managers come out and tell investors that they intend to stick with the dividend for at least, say, the next year. Take them at their word, but it’s a short-term guarantee.

One of the most promising signals of dividend safety, it seems to me, is an increase in payments during a once-in-a-generation downturn in the stock market and economy. We just happen to have a recent one of those handy to judge by. The companies listed below paid more in dividends over the past year than during the one before to add to their long histories of mostly rising payments. They have modest but not meager payout ratios.

Dividend Yield: 3.1%
Payout Ratio: 43%
Payment Record: Increases for 20 consecutive years

Drug maker Abbott Laboratories (ABT) brings in a bit more revenue than Merck (MRK) and well less than Pfizer (PFE) but is growing faster than both. Third-quarter sales for Abbott increased 4% versus a year earlier, despite a drain from currency effects of about five percentage points. Earnings per share rose 17%. Sales of the company’s flagship pill, Humira (for arthritis), jumped 24% after an eight-percentage-point currency drag. Abbott has paid dividends for more than 340 consecutive quarters and last raised its payment in February. Shares trade at 14 times earnings.

Dividend Yield: 3.1%
Payout Ratio: 41%
Payment Record: Payments since 1902, increases since 2004

If a long history of uninterrupted dividend increases is your thing, Campbell (CPB) might disappoint because it trimmed its payment in 2002. But payments today are as high as they’ve ever been, and few companies have paid dividends for more than a century, as Campbell has. Although shares are down about 12% over the past year, the stock price has multiplied tenfold since 1985. Analysts expect sales and profits over the next year to increase 4% and 8%, respectively, but lately they’ve guessed too low. The company surpassed earnings forecasts by double-digit percentages in each of its past two quarters. Shares sell for 14 times earnings.

Dividend Yield: 3.3%
Payout Ratio: 53%
Payment Record: Increases for 47 consecutive years

Johnson & Johnson (JNJ) is perhaps best known for Band-Aids and baby shampoo, but consumer products make up only around one-quarter of the company’s sales, with most of the money coming from drugs and medical devices. Business is soft at the moment, with sales this year expected to decline 4%. That’s a big deal for a company that boasts 76 consecutive years of sales increases. Last week, management announced a restructuring plan meant to help the company ride out a prolonged spending downturn. Through layoffs of 6% to 7% of its work force and simplification of its business structure, the company hopes to reduce costs by $800 million to $900 million next year and $1.4 billion to $1.7 billion annually by 2011. Early forecasts for 2010 call for a resumption of sales growth. Shares fetch 13 times earnings.