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By Jeremy Glaser | 08-10-2010 03:23 PM

Two Golden Dividend Opportunities

Strong, stable cash flows should allow these firms to keep paying shareholders a hefty percentage of their earnings says Morningstar's Josh Peters.

Jeremy Glaser: How to know when a high payout ratio is a golden opportunity or a red flag. I'm Jeremy Glaser with Morningstar.com. I'm here today with Morningstar DividendInvestor Editor Josh Peters, to take a look at a few firms that have very high payout ratios and if investors should be interested. Josh, thanks for talking with me this morning.

Josh Peters: Good to be here.

Glaser: Josh, people usually think of a very high payout ratio is being something to be really worried about. But are there some cases in which it could be a sign that investors should be actually interested?

Peters: When you start looking at a payout ratio, you've got to keep a couple of things in mind. You don't want to set any sort of particular threshold and just say anything above this figure is automatically not going to work unless it's over 100%, really anything under there I think you can start to take seriously.

The kind of things that you want to look at, are the kind of things that I find with one of my favorite stocks, Altria Group.

First of all, it does not have a great deal of financial leverage. Their debt load relative to their cash flow, we think is quite manageable. So, you don't have a great number of other parties that are really lined up in terms of the cash line ahead of your dividend payments.

Second, cash flows from year-to-year tend to be very steady. They have shown good growth, even though consumption of cigarettes has been declining in the United States, the prices the companies have been able to charge has been going up. So, you've got that also working for you. There hasn't been big downward variability in their cash flows.

Another point is, very strong competitive position, they're continuing to hold about half of the domestic market. Since companies in the industry can't advertise, you know really attack each other publicly and directly. They've got very good chance of holding on to that market share without having to spend a tremendous amount of money.

Then finally you've got to look at the capital reinvestment requirements of the business. You think about a utility that might have to invest back hundreds of millions or billions of dollars out of its earnings every year just to grow at 2% or 3% or 4%. Altria doesn't really have to reinvest anything back into the business in order to get its growth, because its growth is all coming through price increases. That doesn't cost a lot of money.

So, you add these different factors up and Altria actually looks like the kind of business that can generate a large growing steady stream of cash that doesn't have to be reinvested, it can actually be paid out to shareholders. That's why the company is targeting paying out 80% of profits on an annual basis as dividends and with that goal having being announced earlier this year, I'm looking for a pretty nice dividend increase from Altria here probably before the end of August.

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