First, dividends are paid in cash. Therefore, if a company is going to pay a dividend it must have cash available. If the company is going to consistently pay and grow its dividend, it must have a vibrant business model that generates a growing level of cash. Unfortunately, most businesses have a degree of variability in which earnings and cash don't grow in a smooth line.
Free Cash Flow PayoutHow well a company can absorb these ups and downs is reflected in its free cash flow payout. Free cash flow payout is calculated as dividends divided by free cash flow (operating cash flows less normal capital replacements). Components of free cash flow are found on the Cash Flow Statement. Free cash flow tells you how much cash the company has left over after paying the normal operating expenses. This is the cash used to pay for acquisitions, debt obligations and dividends!
Debt To Total CapitalIt is not enough to just generate the cash, it has to be available for dividend payments. Many companies generate significant free cash flow, but often that cash is already spoken for in the form of debt obligations. To gauge the relative amount of debt a company is carrying, I look at a debt to total capital metric.
For both free cash flow and debt to total capital, the lower the number the safer the dividend. However, if free cash flow payout is too low, you might question the company's commitment to its dividend.
This week, I screened my dividend growth stocks database for 4 or 5-Star companies with a debt to total capital less than 40, free cash payout less than 60% and with a yield above 2.5%. The results are presented below:
3M Co. (MMM) provides enhanced product functionality in electronics, health care, industrial, consumer, office, telecommunications, safety & security and other markets via coatings, sealants, adhesives, and other chemical additives.
Yield: 2.5% | Debt/Capital: 31.2% | FCF Payout: 55.2%
Texas Instruments Inc. (TXN) is of the world's largest manufacturers of semiconductors, this company also produces scientific calculator products and DLP products for TVs and video projectors.
Yield: 2.5% | Debt/Capital: 27.1% | FCF Payout: 42.3%
Microsoft (MSFT), the world's largest software company, develops PC software, including the Windows operating system and the Office application suite.
Yield: 2.6% | Debt/Capital: 20.8% | FCF Payout: 38.6%
Aflac Incorporated (AFL) provides supplemental health and life insurance in Japan (78% of pretax operating profits) and the U.S. Products are marketed at work sites and help fill gaps in primary coverage.
Yield: 2.7% | Debt/Capital: 20.3% | FCF Payout: 8.5%
Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device and consumer products industries.
Yield: 2.7% | Debt/Capital: 16.6% | FCF Payout: 54.2%
Cisco Systems, Inc. (CSCO) offers a complete line of routers and switching products that connect and manage communications among local and wide area computer networks employing a variety of protocols.
Yield: 2.7% | Debt/Capital: 27.0% | FCF Payout: 35.7%
Emerson Electric Co. (EMR) designs and supplies product technology, and delivers engineering services and solutions to a wide range of industrial, commercial and consumer markets around the world.
Yield: 3.1% | Debt/Capital: 37.3% | FCF Payout: 45.0%
Erie Indemnity Co. (ERIE) is a management services company that provides sales, underwriting, and policy issuance services to the policyholders of Erie Insurance Exchange in the United States.
Yield: 3.1% | Debt/Capital: 0.0% | FCF Payout: 19.9%
Old Republic Intl (ORI) is an insurance holding company that engages mainly in the general (property and liability), title, and mortgage guaranty and consumer credit indemnity run-off businesses.
Yield: 5.1% | Debt/Capital: 12.5% | FCF Payout: 37.2%
As with past screens, the data presented above is in its raw form. Some of the companies would be disqualified for poor dividend fundamentals. However some of the others may be worth additional due diligence.
My database, D4L-Data, is an Open Office spreadsheet containing more than 20 columns of information on the 250+ companies that I track. The data is sortable and has built-in buttons and macros to make it easy to use. Companies included in the list are those that have had a history of dividend growth. The D4L-Data spreadsheet is a part of D4L-Premium Services and is updated each Saturday for subscribers.
Full Disclosure: Long MMM, TXN, AFL, MSFT, JNJ, CSCO, EMR in my Dividend Growth Portfolio and long ERIE, ORI, in my High-Yield Portfolio. See a list of all my dividend growth holdings here.
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