The Top Dividend Yielding Stocks in the S&P 500: Which Should You Choose?

Each year certain companies pay out a portion of their earnings to shareholders in the form of dividends. These payments are your “piece of the pie” for being an owner in the business.

We’ve identified the top eight dividend yielding stocks in the S&P 500 that receive our Attractive or Very Attractive ratings. Each of these stocks pay a generous dividend to shareholders.

We’ve long said that when it comes to investing, you should take the same approach that Warren Buffett does. Mr. Buffett buys stock as if he’s buying not just an asset with a monetary value, but a piece of the company. Abiding by this philosophy, one should be entitled to the profits of the company as well — not just in the form of share price appreciation, but also as dividend payments.

Dividends are can be a great way for CEOs to return their company’s profits to the true owners of that company (the shareholders). However, oftentimes corporations will enact a dividend to create the appearance of shareholder value when that cash would be better put to use correcting issues with the business that lurk under the surface. Knowing the true cash flows of a company allows you to know whether a dividend can be sustained, or if one is even warranted at all.

We’ve compiled a list of the top eight yielding stocks over the past three months in the S&P 500 that also earn our Attractive or Very Attractive ratings. While they currently provide great dividend yields, some of them may be at risk of a dividend cut in the near future. Find out here whether your dividend income is safe or at risk:

  1. Dividend Drop Amid Oil Decline? – Transocean Ltd. (RIG)

Over the past three months, Transocean paid out $0.75 in dividends, ranking it on top of the list with a dividend yield of 3.67%, second among all stocks in the S&P 500. If Transocean continues making this payment over the next year, it would equate to an excellent dividend yield of 14.68%. The biggest question is whether or not Transocean can sustain this dividend.

Transocean provides offshore drilling services for oil and gas wells worldwide. Transocean’s recent 34% drop in stock price has coincided with the rapid decline in oil prices, much like any number of oil related stocks. While this decline may have made the stock price more attractively valued, it has brought added pressure onto the company’s finances. With over nearly $12 billion in total debt(167% of Transocean’s market value) and $4.5 billion in free cash flow on a trailing 12-month (TTM) basis, 2015 will be a pivotal year for this high-yielding stock. To complicate matters further, rating agency Fitch recently affirmed Transocean’s debt rating, but revised its outlook to negative. Fitch expects Transocean to be cash flow negative in 2015, which will certainly put pressure on the ability to pay a dividend going forward.

Over the past three years, Transocean has grown its after-tax operating profit (NOPAT) by over 19% compounded annually. And after its recent price decline, RIG has a price of $19/share and price to economic book value (PEBV) of 0.2, which implies that the market expects Transocean’s profits to permanently decline by 80%. This seems awfully pessimistic over the long term. For its combination of strong profit growth and an undervalued stock, RIG receives our Attractive rating. However as the oil price decline persists, it would appear as if Transocean’s high dividend yield is at significant risk of decline.

  1. Dividend Danger Beneath Surface – Ensco, PLC (ESV)

Ensco ranks second on our list and sixth in the S&P 500 due to its 2.35% dividend yield over the last three months. This equates to an annual dividend yield of 9.40%. This kind of yield on top of the chance of capital gains in the stock price is something all investors should take a look at. However, some of the same issues with Transocean lurk beneath the surface at Ensco.

Like Transocean, Ensco provides offshore drilling services to the oil and gas industry and has seen its share price plummet 40% in the past six months. Because the company’s financials are tied to oil prices, the stock price has moved in unison with oil. At the same time, the price of oil will weigh heavily on Ensco’s dividend in 2015. Ensco has over $6 billion in total debt and generated only $300 million in free cash flow in all of 2013. The longer oil prices stay deflated, the more pressure will be on Ensco to lower its dividend.

Since 2010, Ensco has grown NOPAT by almost 32% compounded annually. ESV’s PEBV of 0.4 at a price of $30/share implies that the market expects its NOPAT to permanently decline by 60%. While this may be likely in the short term, in the long term thus seems extremely pessimistic, and ESV receives our Very Attractive rating as a result. However, with the oil industry in such a state of flux, Ensco may be at risk of a dividend cut in the coming months.

  1. Same Story, Different Name – Noble Corp. (NE)

Noble ranks third on our list and seventh in the S&P 500 with its 1.95% yield over the past three months. Annualized, Noble’s dividend yield is over 7.80%. Unfortunately for dividend investors, Noble falls victim to the same issues outlined above.

Noble, an offshore drilling contractor in the oil and gas industry has not had a good run in the past six months. Its stock price has declined 35% and no end is in sight as long as oil oversupply keeps prices down. Because of this dependency, much like RIG and ESV, the high yield on this stock faces significant headwinds in 2015. Noble has $5 billion in total debt and generated negative free cash flow each of the past four fiscal years. Despite this, the company has paid a quarterly dividend since 2011.

At its current price of $18/share, NE has a PEBV of 0.6, which implies that the market expects Noble’s NOPAT to permanently decline by 40%. While Noble does receive our Attractive rating, much of it is due to the stock’s cheap valuation after its recent price decline. The fundamentals of the business are not as strong as RIG or ESV, and as such, the dividend yield faces risks as long as oil remains deflated.

  1. Can Toys Print Money? – Mattel (MAT)

Mattel ranks fourth on our list and is our first non-oil related stock. Over the past three months Mattel has yielded 1.36% for an annualized dividend yield of 5.44%, which puts it in 12th place in this respect in the S&P 500. Despite this yield being less than half of what the companies above are yielding, Mattel’s financial position is not nearly as volatile. However, this does not mean that the company is in the clear when it comes to its high dividend yield.

Mattel, a manufacturer of numerous toys and games, announced very bad results for 4Q14. The holiday season, which is usually a great time for toy companies and retailers alike, saw Mattel’s revenue decline 6% year over year, especially in sales of its iconic Barbie doll line. Mattel also recently lost its rights to produce products for Disney’s Princess franchises and Frozen movie, which could have been a major source of revenue. With over $2.6 billion in total debt, and only $260 million in free cash flow on a TTM basis, things could be better for Mattel.

Mattel has a short history of dividend growth, paying annual dividends prior to 2011, when it switched to quarterly. Since this switch, Mattel has increased the dividend every year to its current $1.52 annual payout. Mattel earns our Attractive rating with a history of growing profits and economic earnings. While the most recent holiday quarter was by no means a good one for Mattel, the company’s dividend appears solid for the time being. If the poor holiday quarter results become more of a trend, investors will need to consider other options.

  1. Profit From Natural Gas – ONEOK (OKE)

ONEOK is a natural gas company based in Tulsa, Oklahoma. Last quarter ONEOK paid investors a dividend of $0.605, which translates into a quarterly yield of 1.31% and an annual yield of around 5.24%. This makes OKE the 16th-highest yielding dividend stock in the S&P 500.

As a natural gas gatherer and distributor, ONEOK has been hit hard over the past few months, and the company’s stock price has steadily declined 35% since last September. This echoes the experiences of many of the companies we’ve already talked about. However, While ONEOK’s past 12 months were some of its best ever, the company’s choppy free cash flow history should make investors wary of investing in OKE on its dividend alone. While in the past 12 months, ONEOK generated free cash flow of almost $4.1 billion, its cumulative free cash flow since 2009 stands at just a little higher at $4.4 billion. In addition, the company has substantial total debt of $7.7 billion (80% of ONEOK’s market value) and $1.9 billion in deferred tax liabilities (20% of market value). ONEOK is not exactly flush with cash at the moment, and a sustained depression in oil prices will almost certainly put pressure on the dividend.

However, ONEOK remains a solid long-term bet. The company has earned an average return on invested capital (ROIC) of 7% since 2009, and its NOPAT has increased by 9% compounded annually over that timeframe. ONEOK earns our Attractive rating due to its strong history of profit growth and its recently cheap valuation. Again though, we caution investors who are just looking for generous dividend payouts — there are safer bets in this respect elsewhere.

  1. An Old School Player – Philip Morris (PM)

Philip Morris is the United States’ leading cigarette manufacturer. Last quarter Philip Morris paid investors a dividend of $1.00, which translates into a quarterly yield of 1.24% and an annual yield of around 5.24%. This makes PM the 20th-highest yielding dividend stock in the S&P 500.

Philip Morris looks to be in a good position to continue paying out this dividend despite anti-smoking sentiment in this country. Over the past 12 months, Philip Morris generated $10.7 billion in free cash flow, more than enough to cover its annual dividend payments of around $6.2 billion. The company also remains a solid long-term bet with an impressive ROIC of 32% and all-time high NOPAT margins of 13% in the past year. We expect to see some short-term pressure in the stock due to the strong dollar, but this stock represents one of the safest bets for dividend payouts and capital preservation among the highest yielding stocks in the S&P 500. As a result, PM earns our Very Attractive rating.

  1. Effective Management Equals Profits – Franklin Resources (BEN)

Franklin Resources, a holding company better known as Franklin Templeton Investments, is a global investment management firm. Last quarter Franklin Resources paid investors a dividend of $0.65, which translates into a quarterly yield of 1.23% and an annual yield of around 4.92%. This makes BEN the 22nd-highest yielding dividend stock in the S&P 500.

As a growing investment manager, Franklin Resources provides a breath of fresh air from the cheap-but-unstable energy companies found elsewhere on this list. Since 2009, Franklin Resources has grown NOPAT by 22% compounded annually, and the company currently boasts an ROIC of over 33%, one of the highest on this list. Franklin Resources has also increased its NOPAT margins from 21% to 28% since 2009. It looks like this company is firing all cylinders. Despite this, BEN has a PEBV of just 1.2, which implies that the market expects the company to grow profits by no more than 20% for the rest of its lifetime. This cheap valuation makes BEN a steal at current prices.

Not only is this stock primed for share price appreciation, but its dividend is strong and safe as well. The company paid a special dividend of $0.50 per share in addition to its usual $0.15 quarterly dividend, which boosted its yield this past quarter. However, this forward yield of 1.12% is nothing to sneeze at. With free cash flow of $7.3 billion over the last 12 months, Franklin resources can easily cover its annual regular dividend payouts of $373 million, even when accounting for an additional $311 million for the $0.50 special dividend. Franklin Resources balance sheet looks healthy too, with debt of just $1.4 billion (4% of BEN’s market value).

For these reasons and more, BEN earns our Attractive rating.

  1. An Industry Leader – Verizon Communications (VZ)

Verizon is the largest telecommunications company in the United States. Last quarter Verizon paid investors a dividend of $0.55, which translates into a quarterly yield of 1.12% and an annual yield of around 4.48%. This makes VZ the 26th-highest yielding dividend stock in the S&P 500.

With its great fundamentals, Verizon doesn’t need its dividend to keep investors around. Since 2008, Verizon has grown NOPAT by 10% compounded annually and the company currently generates a healthy ROIC of 10%. Over this timeframe, the company has expanded its NOPAT margins from 15% to 21%. Investors can pick up shares of this great company for just $53/share, which gives VZ a PEBV of under 1.2. This number implies that the market expects Verizon to growth NOPAT by no more than 20% for the rest of the company’s lifetime.

As far as its dividend goes, Verizon has no trouble paying out its $9.1 billion annual dividend with free cash flow of $28.6 billion over the past 12 months. There’s also comfortable room for increasing the dividend here. While the company’s total debt of $130 billion (58% of Verizon’s market value) is puts pressure on the amount of cash available to investors, it is certainly not out of the ordinary for the capital-intensive telecom industry. As a result of its strong cash flow and stable profit growth, VZ earns our Attractive rating.

André Rouillard and Kyle Guske II contributed to this report.

Disclosure: David Trainer, André Rouillard, and Kyle Guske II receive no compensation to write about any specific stock, sector, or theme.

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