By Chloe Lutts
Editor of
Dick Davis Investment Digest
and
Dick Davis Dividend Digest
---
Look at Dividend History
Examine Free Cash Flow
Calculate the Payout Ratio
---
Regardless of what other factors you consider as part of your
investing system, there are a few good metrics for everyone to
keep in mind when considering buying dividend-paying stocks for
income.
The first is to simply look at the dividend itself: how long
has the stock been paying a dividend? Has it ever been cut? How
often has it been raised?
Companies that can pay or, even better, increase their
dividends quarter after quarter and year after year are more
likely to continue doing so in the future.
One easy way to find these stocks is to look at Standard &
Poor's list of "Dividend Aristocrats," which are stocks that have
increased their dividends every year for at least 25 years. The
list currently comprises an impressive 51 companies, from
3M (
MMM
)
to
Walgreen Co. (
WAG
).
Bedspring inventor
Leggett & Platt, Inc. (
LEG
)
was the latest Dividend Aristocrat to be recommended in the
Dividend Digest.
In the September 10
Dividend Digest
Daily Alert,
Investors Intelligence
Editors Michael Burke and John Gray wrote:
[LEG is] "only $3 away from its highest level since 2007.
Breaking through there would open up the door for a move towards
the all-time high of $30.68 from 2004. Overall, a clear primary
uptrend, underpinned by trendline support, is underway since the
March 2009 low."
Since then, LEG has moved tantalizingly closer to its
multi-year high at 26 and could actually break that level at any
moment. Plus, being a dividend aristocrat, LEG has paid a
dividend every quarter since the last quarter of 1987, and
currently yields about 4.5%. Oh, and it doesn't just make
bedsprings anymore, the company is a diversified manufacturer of
everything from steel wire to office chair bases.
---
Of course, history isn't the only indication of a dividend's
safety. Another metric that income investors will find very
useful in analyzing dividend-paying companies is free cash
flow.
Free cash flow, simply, equals operating cash flow minus
capital expenditures. In other words, it's what's left of income
after the company spends what is has to. That number is important
because, when all is going well, it's where the money for
dividends come from. (Companies that can't afford to pay their
dividends out of free cash flow are forced to either cut them or
find the money elsewhere, which is usually only a temporary
solution.)
Digests
contributor Ingrid Hendershot, Editor of Hendershot Investments,
wrote about the importance of free cash flow earlier this year,
writing:
"Firms with strong free cash flows can invest in internal
growth programs, fund acquisitions and provide consistent,
value-creating returns to shareholders through growing cash
dividends and share repurchases at attractive valuations. By
following the cash a company generates, investors may determine
if management is allocating the capital in shareholder-friendly
ways."
We've seen some companies with superb cash flow in the
Dividend Digest
recently. The latest
Dividend Digest
featured not one but two recommendations of
NV Energy, Inc. (
NVE
)
, a utility that is using its cash flow to raise its dividend and
buy back shares. One of the recommendations came from
Dow Theory Forecasts
Editor Richard J. Moroney, who wrote:
"The arrow is pointing up at
NV Energy (
NVE
)
, where sales rose 10% in the June quarter after nine consecutive
quarterly declines. The consensus projects profit growth of 58%
this year and 2% next year, and estimates are on the rise in the
wake of profit surprises in the March and June quarters. The
company raised its dividend 31% in May and now yields 3.8%. NV
says it generates sufficient cash flow to support both dividend
hikes of about 10% a year going forward, with enough left over to
retire some debt as well. NV Energy is being upgraded to A (above
average) in our Utility Update and added to the Top 15 Utilities
portfolio."
---
The last important metric I'll address here is a stock's
dividend payout ratio. The payout ratio tells you how much of its
earnings a company is giving to its investors. You can easily
find the payout ratio by dividing a stock's annual dividend
payment by its earnings per share (
EPS
):
For example, a company that reported EPS of $3.00 per share in
2011 and made four quarterly dividend payments of twenty cents
each (for a total yearly dividend of $1) would have a payout
ratio of 33%.
The primary red flag to watch out for when looking at payout
ratios is a number that's too high. With some exceptions for MLPs
and other entities created specifically to pass along cash to
investors, the payout ratio should generally show that the
company has some cash left over to put back into the business,
buy back shares and create a cushion for leaner times ahead.
A company handing over 90% of its earnings to shareholders, in
other words, may have a hard time affording that same payment
down the road. Younger, faster-growing companies generally hold
on to more of their income for growth and stability than older,
slower-growing companies that may feel the best use for the money
is paying back shareholders.
Wishing you success in your investing and beyond,
Chloe Lutts
Editor of
Dick Davis Digests