The Safest Dividends in the S&P 500

One of the things I like best about dividends is that they are paid in cash and thus impossible to fake. With that said, however, dividends can be cut or eliminated altogether if a weak company gets into trouble. Dividend cuts may happen if earnings plummet, debt covenants kick in, acquisitions are made and any number of other reasons. If you’re an investor who relies on dividends to supplement your paycheck or retirement, then the bottom line that you’ll have less income to cover life’s necessities.#-ad_banner-#

The best way to avoid a dividend cut is to limit your investments to financially strong companies that manage their cash conservatively. A key measure for this is the dividend payout ratio, which is the percentage of earnings the company allocates to cover dividends. Lower payout creates a safe cushion for covering the dividend even if temporary setbacks depress the company’s earnings.

The great news for income investors is that we are in the middle of a “Dividend Decade,” a period in which dividends will account for ALL of the market‘s return. This is because a select group of few companies is creating a “Dividend Vault.” Out of fear of yet another economic crisis, these companies started hoarding cash to protect themselves in the future. And now U.S. companies may now have a combined cash stockpile worth a whopping $1.7 trillion in this “Dividend Vault.” And all this money will most likely return to shareholders in the form of dividends.

So I began my search for the market’s safest dividends by running a screen for companies listed in the New York Stock Exchange that have shown steady growth and a consistent track-record of paying dividends, while sporting low payouts and above-average yields. The four companies described below may well be the safest dividends in the S&P 500.

1. Chevron Corp.
Yield 3%
Chevron (NYSE: CVX) is the country’s second-largest integrated oil producer behind Exxon Mobil (NYSE: XOM). The company owns 11.2 billion barrels of oil reserves and produces 2.7 million barrels of oil daily. Chevron also owns 17,800 gas stations operating under the Chevron or Texaco brand names and a 50% interest in a chemicals business. The $4.3 billion acquisition of Atlas Energy two years ago gave Chevron a major presence in the prolific Marcellus shale gas field.
Compared to industry peers such as Exxon, Shell (NYSE: RDS-A) and BP (NYSE: BP), Chevron has higher margins (18.4% versus 11.2% for peers) and less debt (10% of equity versus 23% of equity for peers). Annual growth in earnings per share has averaged 9% in the past five years. 
This dividend champion has a 25-year track record of paying and growing dividends since the company’s merger with Unocal in 2005. Payout is exceedingly modest at 26% and leaves plenty of room for increasing dividends. The last dividend hike was 11% last April to a $3.60 annual rate yielding 3.1%.


2. Cleco Corp.
Yield: 3%
Cleco Corp. (NYSE: CNL) is a regional energy provider that operates as a regulated electric utility serving customers in Louisiana (Cleco Power) and as regulated energy wholesaler (Cleco Midstream). The company scored a major win for its wholesale business last year by signing a 10-year contract to supply power to Dixie Electric Membership Corp. The contract takes effect in April 2014 and is set to increase Cleco’s electric load by more than 20%. As a result, analysts predict Cleco’s annual earnings growth will accelerate from 2% to nearly 6% in the next five years. 
Cleco has paid dividends since 1935 and has recently been growing payments by 8% a year. Payout is conservative at 48%. Since 1987, this “steady eddie” has posted total returns that are 240 basis points better than the S&P 500. Last November, Cleco was recognized by its industry with an award for the best total return in the small-cap stock category. Not to mention, billionaire investor Ken Fisher holds a small position in Cleco stock.


3. General Mills
Yield 3%
Packaged-foods icon General Mills (NYSE: GIS) has annual sales of $16.6 billion and owns many of America’s best-known brands, including Cheerios, Betty Crocker, Pillsbury, Green Giant and Yoplait. General Mills holds the No. 1 or No. 2 market share in baked goods, desserts, yogurt and several other food categories worldwide.
The company has posted healthy earnings growth averaging 7.4% in each of the past three years and 8% earnings per share growth to $1.52 in the first six months of fiscal 2013. Analysts expect higher earnings growth averaging 8% a year for the next five years. 
General Mills has paid dividends without interruption or reduction for 113 years and has grown the dividend 12% in each of the past four years. Payout is prudent at only 46%, which should allow the company to keep growing dividends at an attractive rate. Shares yield 3.1%.


4. Northrop Grumman Corp.
Yield 3%
Given the likelihood of cuts to the defense budget, it may be surprising to find defense contractor Northrop Grumman (NYSE: NOC) on a list of safe dividend stocks. But the company specializes in high-priority categories such as defense electronics, unmanned aircraft and missile defense that are unlikely to see major funding reductions.
Northrop has grown earnings at an average annual rate of 11% in the past five years by building a strong presence in cyber security, surveillance systems and homeland security assets. Excluding pension costs, the company improved earnings by 15% in 2012 to $7.47 a share. 
Northrop has increased its dividend by at least 8% in each of the past five years. The last dividend hike was 10% last May to an annual rate of $2.20 yielding 3.3%. It maintains a low payout of just 27% of earnings and a healthy balance sheet showing $3.9 billion of cash. As a result, Northrop should be able to keep raising its dividend even if earnings growth temporarily slows.

Risks to Consider: Northrop has accumulated pension liabilities totaling $6 billion, which may create a drag on future earnings.

Action to Take –> My top pick overall is Chevron. The company could cover 30 years of production from its current reserves, is more profitable than its peers and will benefit from the inevitable rise of oil prices. I also like General Mills for its dominant market share, accelerating earnings growth and improving dividend. Cleco is a good choice for investors who value consistent performance. Northrop has a bit more risk due to the company’s exposure to military spending cuts.

P.S. — Corporate America is sitting on a $1.7 trillion “Dividend Vault” — and it just might save your retirement. To learn more, click here.