The search for yield remains one of the biggest concerns for investors. Finding yield in a world of zero interest rates is a daunting task, especially given the five-year advance in the equity markets that has pushed prices of many assets to somewhat unreasonable levels.
Many of the usual dividend stocks have seen enormous rallies over the past few years and are no longer candidates for purchase. The most dangerous activity in the market for many investors is yield chasing and accepting higher risks to obtain higher rewards.
Investors need to focus on not just yield but safe yields. We cannot do anything about market risk as that is beyond our control, but we can make sure we focus on dividend stocks that are reasonable priced and financially strong enough to withstand the fluctuations in the market and the economy.
We can use two measurements to make sure we are buying a safe companies at reasonable prices when searching for dividends. The enterprise-to-EBITDA ratio is the measurement used by many private equity and leveraged buyout investors to measure the total value of a corporation. I was told by one very successful private equity investor years ago that a measure of five or less was his cutoff for companies to be considered undervalued.
The Altman Z-score is a measure of financial risk developed by Professor Edward Altman of New York University. Companies that score 2.99 or higher using this measure are considered in the safe zone with little financial or liquidity risk. We can combine the enterprise-to-EBTIDA ratio with the Altman Z-score to look for stocks that have high yields and are safe and cheap for income investors.
Safe Dividend Stocks: Royal Dutch Shell (RDS.A)
One large company that fits the bill is Royal Dutch Shell (RDS.A). The Netherlands-based oil and gas giant has been falling along with oil prices lately, and Shell stock is now at bargain levels. RDS.A yields 5.5% at the current reduced prices, and the financials are safe and solid as Royal Dutch has a Z-score of 3.12. Shell stock is also undervalued, with an enterprise-value-to-EBITDA ratio is 4.9.
Safe Dividend Stocks: Sturm, Ruger & Co. (RGR)
Firearm manufacturers have fallen out of favor with the market after last year’s mad, gun-control-related sales rush in the U.S. has created difficult year-over-year comparisons. Sturm, Ruger & Co. (RGR) makes rifles, pistols and shotguns, and RGR stock has fallen sharply this year. Now the stock trades with an EV/EBITDA ratio of just 4.9, and the dividend yield is 4.2%. The Z-score is 12.65, so the company is rock-solid, financially.
Safe Dividend Stocks: IDT Corporation (IDT)
IDT Corporation (IDT) has an interesting mix of businesses. The company sells prepaid phone cards to immigrant customers tin Europe, Asia, Africa and the U.S. IDT also offers landline phone service and also have an online game platform. IDT stock has fallen recently on earnings concerns and is currently yielding 4.68%. The stock is cheap, with an EV/EBITDA ratio of 4.5, and safe with a Z-score of 3.67.
When looking for dividend stocks, make sure you consider the price you are paying and look to buy only stocks sitting at cheap values. In addition, make sure that your dividend stocks have the strong financial condition needed to survive through any market or economic cycle.
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As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.