How to pick winning dividends

Metrics can tell us which companies will keep paying their dividends, but not necessarily which ones will fail.

It's one thing for a stock to have a good dividend, and another to know that it's going to be around in a year.

Commonly used metrics like the dividend payout ratio — the percentage of earnings paid as dividends — aren't very good at identifying whether individual dividends will disappear. But they can help investors pick out a handful of companies that will almost certainly not cut their dividends, according to a CNBC analysis.

One in five companies in the S&P 500 have unhealthy payout ratios above 100 percent, but fewer than 20 percent will end up cutting their dividends in a given year or the next year. More of those at-risk companies will actually raise their dividends.

On the other hand, companies with healthy payout ratios are much less likely to cut dividends and usually raise them, which was true even during the last recession. That means companies with healthier ratios probably will continue paying during a worst-case market scenario.

An even stronger method for predicting which dividends will increase is the DIVCON rating system developed by Reality Shares Advisors. Like the military's DEFCON system, a lower score means a dividend is riskier. The model predicts dividend actions based on seven factors (but not the dividend payout ratio), and it has a very strong track record.

In backtesting, companies with the healthiest rating (DIVCON-5) have raised their dividend 97 percent of the time, and have never decreased them. But the system has a similar weakness in predicting which companies will reduce dividends. They are the ones with the worst rating (DIVCON-1) only decreased their dividends 30 percent of the time.

Here are the biggest companies in each rating category:

Investors want a high yield on their investment in dividend stocks, but the companies with the highest yields often have some of the worst DIVCON scores and payout ratios. Those inevstors can make the mistake of buying dividend stocks based on yield or a company's well-known name without taking into account the risk of a dividend reduction.

"Just because they're a well-known name doesn't mean that they have the healthiest dividend or the best dividend if you combine that information with yield and other factors," said Kian Salehizadeh, senior analyst at Reality Shares.

The best DIVCON-rated companies like Southwest Airlines and Nike may be safe bets, but they pay relatively low yields. It's possible to get both above-average yields and the security of a dividend that's going to stick around for a while. Below are companies that have it all: low payout ratios, DIVCON 5 ratings and high dividend yields.

Measuring the riskiness of dividends is also one way to look at the market as a whole. Payout ratios and DIVCON scores are generally loosely aligned, but the two measures have diverged recently.

While the payout ratio shows a market at high risk for dividend cuts, DIVCON scores show a dividend market that's at its healthiest level in years. Salehizadeh said the market is generally becoming healthier because companies are willing to go out of their way to keep their dividends growing.

"Dividends in general are becoming more healthy because companies will make changes at the fundamental level to try to preserve them because they're such a big signal to investors," he said. "Even energy companies that were recently at risk are cutting back in other areas to maintain their dividends."

The companies that are truly at risk are those that have already cut everything they can. While they still have other options, most companies will usually decide to make sacrifices to maintain their dividend for signaling purposes, even in severe downturns. The most likely outcome for this year is positive dividend growth, even if that growth slows, Salehizadeh said.

"Most likely we will see another positive year for dividends but not a double-digit year for growth," he said. "We're not necessarily going to get record growth, but the biggest payers in the S&P 500 will likely increase, even if it's just a little bit."