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Two Dividend Stars to Buy Now

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Finding a big yield isn't the true measure of a quality income stock, so take your time in choosing since good dividend payers should be very long-term choices.

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We've seen some companies with superb cash flow in the Dividend Digest recently. The latestDividend Digest featured not one but two recommendations of NV Energy (NYSE:NVE), a utility that is using its cash flow to raise its dividend and buy back shares. One of the recommendations came from Dow Theory Forecasts Editor Richard J. Moroney, who wrote:

"The arrow is pointing up at NV Energy, where sales rose 10% in the June quarter after nine consecutive quarterly declines. The consensus projects profit growth of 58% this year and 2% next year, and estimates are on the rise in the wake of profit surprises in the March and June quarters. The company raised its dividend 31% in May and now yields 3.8%. NV says it generates sufficient cash flow to support both dividend hikes of about 10% a year going forward, with enough left over to retire some debt as well."

The last important metric I'll address here is a stock's dividend payout ratio. The payout ratio tells you how much of its earnings a company is giving to its investors. You can easily find the payout ratio by dividing a stock's annual dividend payment by its earnings per share (EPS). For example, a company that reported EPS of $3 per share in 2011 and made four quarterly dividend payments of 25 cents each (for a total yearly dividend of $1) would have a payout ratio of 33%.

The primary red flag to watch out for when looking at payout ratios is a number that's too high. With some exceptions for MLPs and other entities created specifically to pass along cash to investors, the payout ratio should generally show that the company has some cash left over to put back into the business, buy back shares and create a cushion for leaner times ahead.

A company handing over 90% of its earnings to shareholders, in other words, may have a hard time affording that same payment down the road. Younger, faster-growing companies generally hold on to more of their income for growth and stability than older, slower-growing companies that may feel the best use for the money is paying back shareholders.

Editor's Note: This article was written by Chloe Lutts of Dick Davis Dividend Digest.

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No positions in stocks mentioned.
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