The safest dividend in the Dow

"In theory, stocks represent more risk than Treasuries, so you want to make sure you're getting compensated for that risk with a higher yield.

"Using the yield of the 10-Year Treasury as our threshold eliminates most of the Dow. Though the Dow components pay an average dividend yield of 3.3%, about 40 basis points higher than the S&P 500 Index, we find that only seven Dow components yield more than the 10-Year Treasury.

Kraft (NYSE: KFT) -- 4.4%
Caterpillar (NYSE: CAT) -- 4.4%
Pfizer (NYSE: PFE) -- 4.5%
Merck (NYSE: MRK) -- 5.9%
DuPont (NYSE: DD) -- 6.1%
Verizon (NYSE: VZ) 6.3%
AT&T (NYSE: T) -- 6.8%

"Next, I want to be sure the outlook for the company is stable. If there is notable trouble on the horizon, one place it will show up is in a company's projected earnings.

"For the purposes of this analysis, I'll shy away from any company expected to show more than a -5% decline in earnings this year, based on the consensus Bloomberg estimate.

"Considering the challenges of the current economic environment, it's not surprising that this analysis takes five more companies out of contention. As such, we're left with just two firms: Kraft and Verizon.

"Remember, safety is the first and most important criteria I look at when examining a dividend-paying stock.

"With that in mind, I decided to look into the most recently reported quarter for each company and compare net earnings to total dividends paid. We must exclude any company that paid more in dividends than it earned.

"That sort of arrangement is unsustainable. Any company whose dividend costs exceed its net earnings lacks the margin of safety that conservative income investors in this market must demand.

"This is a tough hurdle to clear: The first quarter of 2009 presented extremely difficult operating conditions. Any company able to comfortably maintain its distributions in such a challenging environment clearly has demonstrated a wide economic moat. Here are the results:

• Kraft earned $662 million and paid out $426 million for a payout ratio of 64.7%.
• Verizon earned $1.6 billion against its $1.3 billion dividend obligation for a payout ratio of 79.4%.

"We're still left with two companies. Both Kraft and Verizon have above-average yields, have a stable outlook and have demonstrated an ability to cover their dividends under tough economic conditions.

"At this point, I'll turn to history as a guidepost, looking at each company's average P/E, dividend growth rate and average annual total returns for the past five years.

"Amazingly, both companies are trading at almost identical discounts to their five-year average P/E. If each stock returned to its average P/E, Verizon would appreciate +37.1% while Kraft would appreciate +37.2%.

"Apparently that's not going to break a tie. Verizon does yield 1.9% more than Kraft, although Kraft has grown its dividend at a faster rate.

"Both companies also outperformed the S&P 500's annualized total returns for the past five years. But Verizon outgained Kraft by +1.7% a year -- by almost the same amount as its dividend premium over Kraft.

"As a telecommunications provider, Verizon is an essential service with high subscriber loyalty. Meanwhile, Kraft Foods includes strong consumer food brands like Kraft cheeses, Oscar Mayer meats and Nabisco cookies.

"Both companies boast of above-average yields and both dividends passed my stringent safety criteria.

"If pressed, I'd have to tip the scale to Verizon for the safest dividend in the Dow. Its higher 6.3% yield has made a positive impact on its total returns. And that difference is something we income investors can take to the bank."

Steven Halpern's TheStockAdvisors.com offers a free daily overview of the favorite stock picks and investment ideas from the nation's leading financial newsletter advisors.