It's not that most companies have done anything wrong when preparing their Statement of Earnings, but under Generally Accepted Accounting Principles (GAAP) a lot of the entries have nothing to do with today's operations. Given this, I generally avoid most earnings related metrics (e.g. EBIT, EBITDA, payout ratio, etc.)
The cash flow statement is not based on accrual accounting, but instead is a cash-basis report focusing on inflows and outflows of cash. It adjusts for transactions that do not directly affect cash receipts and payments, such as adding depreciation back to net earnings. The cash flow statement allows investors to understand how a company's operations are running, where the cash is coming from and how it is being spent.
As an investor in dividend growth stocks, I want to know if a company is financially capable of paying me a higher dividend each year. That's why I focus on cash-based metrics such as these:
Free Cash FlowThis has many definitions, but the one I use is operating cash flow less capital expenditures. Capital expenditures are deducted since you can't run a business for any period of time without expending some level of capital. These two numbers are easily located on the Statement of Cash Flows. This is the best snapshot of what cash the business has generated from "normal" operations and is available for dividends, debt, acquisitions and purchases of treasury stock.
Cash Flow Per Diluted ShareGAAP Earnings Per Share (EPS) has the same short-comings as GAAP earnings. When looking at per numbers I prefer a cash-based number. Cash Flow Per Diluted Share is calculated by taking the Free Cash Flow from above and dividing it by diluted shares outstanding (available on the Statement of Earnings).
Cash Payout RatioDividend investors love payout ratios (dividends per share divided by EPS). Given my concerns with GAAP earnings and EPS, I once again prefer a cash-based version. The Cash Payout Ratio is calculated by dividing dividends per share by Cash Flow Per Diluted Share. Care should be taken when interpreting this ratio. For example, sometimes a high ratio with low debt is better than a low ratio with high debt.
Cash Return on Capital EmployedThis is simply Free Cash Flow divided by Total Capital (debt + equity). Again, I prefer using a cash number in the numerator. A lot of investors look at return on assets and return on equity. Each are flawed beyond their GAAP numerator. Return on assets ignores the liabilities side of the balance sheet, while return on equity ignores the debt component of capital.
You can fake earnings, but you can't fake cash.
This week, I screened my dividend growth stocks database for select non-financial dividend stocks that have a free cash flow payout of 50% or less with a yield of 3.0% or more. The results are presented below:
Target Corp. (TGT) operates nearly 1,800 Target, SuperTarget and CityTarget general merchandise stores across the U.S. Yield: 3.1% | FCF Payout: 33.9%
Cincinnati Financial Corp. (CINF) is an insurance holding company that primarily markets property and casualty coverage. It also conducts life insurance and asset management operations. Yield: 3.2% | FCF Payout: 30.2%
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: 3.2% | FCF Payout: 37.1%
Eaton Vance Corp. (EV) engages in the creation, marketing and management of investment funds in the US. EV also provides investment management and counseling services to institutions and individuals. Yield: 3.4% | FCF Payout: 48.1%
Wal-Mart Stores, Inc. (WMT) is the largest retailer in the world, operating a chain of over 10,000 discount department stores, wholesale clubs, supermarkets and supercenters. Yield: 3.3% | FCF Payout: 43.3%
Brady Corp. (BRC) operates as an international manufacturer and marketer of identification solutions and specialty products which identify and protect premises, products and people. Yield: 3.5% | FCF Payout: 30.5%
Cracker Barrel Old Country Store (CBRL) develops and operates the Cracker Barrel Old Country Store restaurant and retail concept in the United States. Yield: 3.5% | FCF Payout: 42.5%
Sonoco Products Co. (SON) makes paper and plastic packaging products serves various industries and markets in more than 85 countries. Yield: 3.6% | FCF Payout: 45.8%
IBM's (IBM) global offerings include information technology services, software, computer hardware equipment, fundamental research, and related financing. Yield: 3.9% | FCF Payout: 37.6%
Westwood Holdings Inc. (WHG) provides investment advisory services to a wide range of institutional clients, and also provides trust and custodial services. Yield: 4.4% | FCF Payout: 28.6%
As with past screens, the data presented above is in its raw form. Some of the the companies would be disqualified for poor business 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 CINF, CSCO, WMT in my Dividend Growth Portfolio, and long CBRL, IBM in my High-Dividend Growth Portfolio. See a list of all my dividend growth holdings here.
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