In my criteria for the best dividend stocks, I typically focus on companies that have a sustainable dividend payment. A sustainable dividend payment is one where the ratio of dividends to earnings per share in a given year does not exceed 60%. In addition, I also focus on the price/earnings ratio, which is a ratio of the stock price over the annual earnings per share.
Thus, astute readers will notice that earnings per share is a key component of my analysis — as it is part of the P/E and dividend payout ratio calculations. For my analysis of earnings per share, I tend to focus on income from continuing operations. These generate earnings from sources, which have a high chance of recurring for many years. Many companies however generate one time gains or losses which directly affect earnings per share. As a result, I tend to “normalize” this key indicator, in order to have an objective analysis.
In a previous article, I expressed my concerns over the sustainability of AT&T’s and other telecom companies’ dividend payments. On the surface however, it looked that AT&T earned $3.35/share in 2010. This represents the highest EPS amount ever. In addition, the P/E ratio seems to be 8.5, while the dividend payout ratio is 51.3%.
When you drill further into the AT&T earnings figures and switch to a quarterly view however, one would notice that the company earned $1.95 in the third quarter of 2010. This was much higher than the $0.54/share earned in the third quarter of 2009, and much higher than the $0.68/share earned in the second quarter of 2010. I researched the issue, and found this press release from the company’s website:
“Third-quarter 2010 net income attributable to AT&T totaled $12.3 billion, or $2.08 per diluted share, including $1.53 in one-time gains from a previously disclosed tax settlement and the sale of Sterling Commerce”.
This shows that the company earned $1.53/share from a one-time gain. In addition, $0.13/share came from discontinued operations. This leads to a normalized EPS of $0.42 for the quarter, which decreases earnings per share for 2010 to $1.69/share. As a result, the dividend payout ratio looks closer to 100%, whereas the P/E ratio looks close to 16.70. Even if AT&T manages to earn $2.40/share in 2011, its dividend coverage is still unsustainable at 72%. Check my analysis of the stock.