7 Dow Dividend Stocks Safer Than T-Notes

Correction: The original version of this article incorrectly demonstrated the impact of rising interest rates on the present value of a bond. The example in the first paragraph has been generalized.

NEW YORK, NY (TheStreet) -- Tuesday's stock market selloff has scared flocks of investors into the "safety" of 10-year Treasury notes, driving yields below 3% -- a 14-month low. Of course, higher-priced Treasuries are more susceptible to interest rate risk (as interest rates rise, the market value of the bond lessens), thus, a seemingly innocuous investment may actually be risky.

If this trend continues, fixed-income investors (read: retired persons) will find themselves in a precarious position: How much capital can be sacrificed for current income?

Unfortunately, there are no risk-free investments, but a "dividend acid test" can be used to determine the relative safety of an income investment. The following formula is designed to protect income investors from substantial loss of principal while providing a high level of current income:

Dividend Acid Test Formula
(10-Year Treasury Yield) less than (Stock Dividend Yield) less than (Liability-Adjusted Cash Flow Yield)

By ensuring that the stock's dividend yield is less than the liability-adjusted cash flow yield (LACFY), investors can be reasonably confident that an operational incident or upcoming debt maturity won't derail their dividend check. (The formula isn't perfect, but a pre-spill BP would not have passed this test.) This formula also demands that the LACFY be greater than the 10-year Treasury yield, providing investors with a Benjamin Graham inspired margin of safety.

Of the 30 stocks on the Dow Jones Industrial Average, only seven meet these criteria.

7. Procter & Gamble

• Liability-Adjusted Cash Flow Yield: 3.6%
• Dividend Yield: 3.18%
• 10-Year Treasury Yield: 2.97%
• Calculated Margin of Safety: 1.21 (a ratio greater than 2 is desirable)

Procter & Gamble (PG) isn't as profitable as it once was, but CEO Bob McDonald is working hard to rectify the situation. The company is focusing its efforts on the high-margin personal grooming and beauty market while divesting from noncore businesses (most notably, selling Folgers to J.M. Smucker (SJM)).

Of all the companies on this list, P&G carries the second-highest level of debt and trades at the highest valuation -- but has the advantage of pricing power in a consumer-inflationary environment.

6. Coca-Cola

• Liability-Adjusted Cash Flow Yield: 4%
• Dividend Yield: 3.45%
• 10-Year Treasury Yield: 2.97%
• Calculated Margin of Safety: 1.35

Coca-Cola (KO) is a goodwill giant of American culture, and a longtime portfolio holding of Warren Buffett. In the face of 2009's financial crisis, the company's management trimmed executive compensation by a whopping 45%.

Buffett has long extolled the virtues of managerial integrity, and retail investors should take note -- excessive pay is a detriment to shareholder value. At today's valuation, Coca-Cola isn't a bargain, but it isn't a value trap.

5. Home Depot

• Liability-Adjusted Cash Flow Yield: 4.1%
• Dividend Yield: 3.19%
• 10-Year Treasury Yield: 2.97%
• Calculated Margin of Safety: 1.38

Home Depot (HD) became a better investment the day that Chairman/CEO Bob Nardelli vacated office with a sickening $210 million severance package. Executive compensation is now half of what it was in 2005, and the company has prudently frozen its dividend while it rides out the recession.

For a retailer with a $48 billion market cap, Home Depot has an impressive 11% return on invested capital (using 10-year data) -- when a recovery takes hold, Home Depot should emerge stronger.

4. Johnson & Johnson

• Liability-Adjusted Cash Flow Yield: 5.8%
• Dividend Yield: 3.63%
• 10-Year Treasury Yield: 2.97%
• Calculated Margin of Safety: 1.95

Johnson & Johnson (JNJ) is a favorite holding among institutional money managers and retail investors alike. With a hefty 3.6% dividend yield and a comfortable 5.8% liability-adjusted cash flow yield, J&J seems like a slam dunk, but there are some misgivings.

The pharmaceutical giant's effective tax rate ranges between 15% and 23% -- which is well below the industry norm. Management may be legally (and wisely) exploiting tax breaks and loopholes, but a cautious investor must ask how long it can last.

3. Pfizer

• Liability-Adjusted Cash Flow Yield: 6%
• Dividend Yield: 4.95%
• 10-Year Treasury Yield: 2.97%
• Calculated Margin of Safety: 2.02

Pfizer (PFE) is an interesting stock to find on this list, considering that the company dramatically slashed its dividend in early 2009 to fund its acquisition of Wyeth. At the time Pfizer announced its dividend cut, it would not have passed the dividend acid test.

Pfizer seems like a good value today, but the stock might constitute a value trap -- the company's effective tax rate is less than 20%.

2. Exxon Mobil

• Liability-Adjusted Cash Flow Yield: 6.3%
• Dividend Yield: 3.01%
• 10-Year Treasury Yield: 2.97%
• Calculated Margin of Safety: 2.12

Exxon Mobil (XOM) has been unduly punished by the BP oil spill and congressional regulatory fears. When a company is nearly three times as profitable as its peer group, trading at the best valuation in its industry, and is scraping a 52-week low -- value investors would be wise to take notice.

Exxon may not have the highest dividend in the oil industry, but management has a long history of timely share buybacks, ultimately delivering greater value to owners. At today's depressed valuation, a 3% dividend from this oil titan screams "bargain" to those with an open ear.

1. Intel

• Liability-Adjusted Cash Flow Yield: 6.6%
• Dividend Yield: 3.09%
• 10-Year Treasury Yield: 2.97%
• Calculated Margin of Safety: 2.22

Intel (INTC), like Microsoft (MSFT), trades more like a bond than a stock. Both companies enjoy a virtual monopoly in their industries and generate healthy cash flows, but the stigma of being a "tech" company that has outgrown its growth phase keeps these stocks in a tight trading range.

While Microsoft has generally dismissed the mobile revolution, Intel has inked a deal to provide Nokia (NOK) with mobile technology which may contribute to growth prospects (and lift Nokia's Finnish foot from the grave). With a LACFY of 6.6%, Intel sports a comfortable margin of safety.

-- Written by John DeFeo in New York CityFollow @johndefeo