3 Dividend Payers That Are Buys and 3 That Aren't

When run well, insurance companies can be some of the safest dividend stocks in the business. They produce copious free cash flow from their premiums that can be invested before claims are filed.

In fact, Warren Buffett's Berkshire Hathaway (NYS: BRK.B) has several insurance companies creating the foundation for his hugely successful company. Today, I will introduce you to three dividend-paying insurance companies that are a safe bet in uncertain times and three that you should question before buying.

A starting place -- dividend yields
Of course, every investor wants high yields. If you have your dividend stocks on an automatic dividend reinvestment plan, high-yield stocks will automatically allow the phenomena of compounding work its magic over the years.

Below are six insurance stocks, all with attractive yields above 2.5%.

Source: dividendinvestor.com.

If we were only looking at dividend yields, then it would be clear that Cincinnati Financial, Sun Live, and Arthur Gallagher would be my three recommendations.

It's not that simple
Knowing how important dividends can be, we investors also can't forget to examine how sustainable a company's dividend is. One of the most popular metrics for doing so is the earnings payout ratio, which essentially measures the amount of earnings a company dedicates to paying out dividends. As the theory goes, the lower the payout ratio is, the more sustainable the dividend is.

Take a look at how our six stocks stack up now.

Source: dividendinvestor.com.

In their book Million Dollar Portfolio, David and Tom Gardner suggest that you should hold only stocks with a payout ratio of less than 65%. Clearly, this benchmark would make the cautious Fool worry about the sustainability of dividends from the likes of Cincinnati Financial, Arthur Gallagher, and Marsh & McLean. It's interesting to note that two of these three supposedly "unsafe" dividends are also the high yielders.

But wait, we're still not done!
We need to take one more step back. While it's true that it's never a good sign for a company to have a payout ratio above 65%, it's also a fact that sometimes, there are one-year anomalies.

For one reason or another, a company may have higher claims to pay out than is normal. Take Aflac, for instance, which does a majority of its business in Japan -- a country ravaged by an earthquake, tsunami, and nuclear meltdown.

To check for more durable patterns, I zoomed out and looked at the average payout ratio for these companies over the past five years. Check and see how this changed things.

Source: dividendinvestor.com.

Wow, taking this new view really changed things for some of our companies. Sun Life, which had looked pretty safe, has a sky-high payout ratio over the past five years. This most likely has to do with the fact that though earnings deteriorated during the financial crisis, Sun Life maintained its regular dividend. Though this fact leaves Sun Life off my final list, it shows how substantial cash-flow streams are for insurance companies.

At the same time, Cincinnati Financial -- which was in the danger zone -- has established itself as a safe dividend investment over the past five years. Along with Protective Life and Aflac, Cincinnati rounds out the three stocks that have shown themselves to truly be careful dividend payers over the past five years.

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At the time thisarticle was published Fool contributorBrian Stoffelowns shares of Berkshire Hathaway and Aflac. The Motley Fool owns shares of Berkshire Hathaway and Aflac.Motley Fool newsletter serviceshave recommended buying shares of Berkshire Hathaway and Aflac. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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