Are European dividend stocks the land of milk and honey?

On a screening of stocks in the S&P 500 and STOXX 600 for their indicated yield and dividend coverage based on both earnings and cash flows, it seems European counters offes the most attractive dividend yields when taking dividend cover into account. In fact, no US stocks are among the top 20 dividend yielding stocks.

Dealing with dividends divides the investment and academic community
Opinions about how dividends affect the value of the issuers are many, but modern corporate finance theory holds that dividends do not change the overall market value of the underlying company paying out dividends.

But the returns on the S&P 500 would beg to differ with this particular theory, which covets some unrealistic assumptions. Since the end of 1988 the S&P 500 index has returned pre-tax 280.3 percent compared to 524.4 percent when you include the reinvestment of dividends; that translates into an annualised pre-tax return of 6.1 and 8.4 percent respectively.

A high dividend yield in itself is not attractive though. It has to be backed up by either momentum in the underlying business fundamentals or a good dividend coverage ratio. Based on indicated dividend yields and dividend coverage ratio we have produced what may be the 20 best dividend stocks in the S&P 500 and STOXX 600 Indices.

These 20 stocks represent an equal-weighted indicated dividend yield of 7.0 percent (note that it differs from the 6.5 percent median in the table) compared to 4.2 percent in the Euro STOXX 600 Index and 2.3 percent in the S&P 500 Index. In addition, the median forward price earning is 7.0 and the median dividend coverage ratio is 6.0 times. Note, no U.S. stocks make the list.

Before jumping into the European dividend river of milk and honey, however, consider if the individual stocks fit your portfolio and risk profile. For instance, can you live with an exposure to Barclays when financial stocks are so volatile?

So how did we find these dividend stocks?
We started by narrowing the universe to the S&P 500 and STOXX 600 indices. Then we retrieved the indicated yield, last year’s dividend and earnings per share, last year’s free cash flow to equity (cash flow from operating minus capital expenditures plus net borrowings), last year’s dividends and net change in capital stock (essentially the difference between issuances and repurchases of shares in nominal terms). Then we calculated the dividend coverage ratio (earnings per share / dividends per share) and the FCFE coverage ratio (free cash flow to equity / dividends paid + net issuances and repurchases). We ranked the universe of 1,100 stocks on their indicated dividend yield and two dividend coverage ratios (three factors) and combined them into a single factor based on a 50/25/25 weighting of the three factors respectively. The 20 stocks with the best combined ranking become our list of preferred dividend stocks.