As part of my efforts to focus my time spent doing due diligence stock research on companies that have a high chance of being worthy investments I spend a respectable amount of time fiddling with my stock screens. While ratios and percentages that fall within a certain range of values can’t guarantee that I’ll always pick the next generation or two worth of Dividend Aristocrats they can help guarantee that I don’t select those companies whose tickers have disappeared from the nation’s stock exchanges all together. Most of my recent tweaking of my screens has revolved around finding companies with very secure dividends, which is to say the company has the financial mojo to keep paying them, at increasing rates, when earnings slump. Therefore I have looked beyond the standard dividend payout ratio (dividends per share divided by earnings per share) to metrics like the free cash flow payout ratio and how many quarters of payouts a company’s cash hoard can cover in order to get a more accurate fix on how safe potential income streams really are.
First let me explain why I am including the free cash flow (FCF) payout ratio in my stock analysis instead of just the dividend payout ratio. The dividend payout ratio is based on a company’s earnings while the FCF payout ratio is based on a company’s FCF, which is determined by subtracting capital expenditures from operating cash flow. FCF is therefore cash that the company is free to employ as it chooses after taking care of its obligations to upgrade and expand its physical asset base. While earnings can be manipulated to look good by accountants (which opens up a can of worms ranging from the sale of depreciated assets to the effects of share buybacks) FCF is straight up cash, and cash is hard to mess around with (see this post from Dividends Value that touches on why earnings are not the same as cash). The purpose of both metrics is to determine the proportion of capital that has been generated by the company that is being returned to shareholders in the form of dividends. Since FCF is a more accurate reflection of the real amount of cash available for a company to use it would appear to be a better metric to use than the standard dividend payout ratio.
The second new metric I am looking at is one that I am still experimenting with in regards to a proper benchmark value as well as general validity. Specifically it looks at how much cash a company has available (taken from its most recent 10-Q) filing and compares it to the total amount of dividends paid out over the trailing twelve month period (TTM). The premise is that if a company were to have an extremely poor year and was not able to generate enough FCF to cover its dividend payment that it would have to utilize its cash reserves in order to continue to fund the dividend. Furthermore since I require companies in my portfolio to increase their dividends annually the company would also have to have enough cash on hand to not just sustain the current payout but also to increase it. Given that the companies that are eligible for inclusion in my portfolio are there on the basis of their strength as cash generators and consistent dividend payers the chances of such a bad year happening to them are very low thus making this metric very, very conservative. Even so for the time being I am setting a preference of 1.00 as my required value for this ratio (meaning that cash on hand should be enough to cover one year of dividends based on the TTM dividend payout).
So those are the two new metrics that I am going to apply to the basket of stocks turned up by today’s screen. Before I list those stocks I should point out that in addition to using my four basic criteria , to which I modified the values I screened for a bit, I also included two new metrics. One was simply market capitalization: I wanted companies that had a capitalization of at least $1 billion, down the line I will make a concerted effort to look for more small-cap dividend payers but not today. I also used Return on Equity in the screen, which tells me how effective the company is at using shareholder’s money to create value. So I put these two criteria plus my three of my original four (less cash on hand) into the Fidelity.com screener so that the entire screen looked like this:
Dividend Yield | Between 3% and 7% |
5-Year Average Dividend Growth Rate | Between 10% and 25% |
Dividend Payout Ratio (Last Quarter) | Between 25% and 60% |
Return on Equity | Greater than 15% |
Market Capitalization | Greater than $1 Billion |
This screen returned a basket of 15 stocks which I have listed below in order from highest yield to lowest yield:
Company | Ticker | Yield | Div Growth | Div Payout | ROE | Market Cap |
Alliance Resource Partners | ARLP | 5.60% | 13.03% | 54.79% | 73.03% | $2.4B |
Raytheon Co. | RTN | 4.25% | 12.37% | 34.93% | 19.62% | $14.3B |
Conoco Phillips | COP | 4.10% | 12.89% | 26.95% | 16.59% | $88.4B |
Intel | INTC | 3.81% | 16.00% | 32.53% | 25.36% | $115.7B |
Abbott Laboratories | ABT | 3.75% | 10.23% | 38.87% | 21.68% | $79.7B |
Greif Inc. | GEF | 3.63% | 18.47% | 39.03% | 17.64% | $1.2B |
Clorox Co. | CLX | 3.56% | 15.65% | 43.45% | 489.00% | $8.9B |
Eaton Corp | ETN | 3.49% | 11.76% | 34.52% | 15.36% | $13.3B |
Pepsico Inc | PEP | 3.40% | 11.41% | 40.41% | 28.87% | $95.9B |
Illinois Tool Works Inc | ITW | 3.28% | 11.38% | 35.16% | 19.49% | $21.5B |
General Mills Inc. | GIS | 3.20% | 11.75% | 49.38% | 28.42% | $24.6B |
General Dynamics Corp | GD | 3.19% | 15.36% | 26.43% | 19.47% | $21.3B |
Eaton Vance Corp | EV | 3.18% | 12.47% | 32.04% | 47.51% | $2.7B |
Aflac Inc | AFL | 3.14% | 18.20% | 44.80% | 15.94% | $17.9B |
Brinker International Inc | EAT | 3.01% | 19.14% | 29.08% | 27.15% | $1.8B |
In this table I get rid of the market capitalization column and ROE column and replaced them with a FCF payout ratio column and a years of cash protection of the dividend column:
Company | Ticker | Yield | Div Growth | Div Payout | FCF Payout | Protection |
Alliance Resource Partners | ARLP | 5.60% | 13.03% | 54.79% | 84.48% | 0.7 |
Raytheon Co. | RTN | 4.25% | 12.37% | 34.93% | 59.08% | 1.6 |
Conoco Phillips | COP | 4.10% | 12.89% | 26.95% | 62.95% | 1.0 |
Intel | INTC | 3.81% | 16.00% | 32.53% | 46.18% | 1.3 |
Abbott Laboratories | ABT | 3.75% | 10.23% | 38.87% | 36.03% | 1.3 |
Greif Inc. | GEF | 3.63% | 18.47% | 39.03% | -84.75% | 0.5 |
Clorox Co. | CLX | 3.56% | 15.65% | 43.45% | 79.01% | 0.3 |
Eaton Corp | ETN | 3.49% | 11.76% | 34.52% | 40.12% | 0.6 |
Pepsico Inc | PEP | 3.40% | 11.41% | 40.41% | 72.19% | 0.4 |
Illinois Tool Works Inc | ITW | 3.28% | 11.38% | 35.16% | 63.99% | 0.8 |
General Mills Inc. | GIS | 3.20% | 11.75% | 49.38% | 79.20% | 0.2 |
General Dynamics Corp | GD | 3.19% | 15.36% | 26.43% | 30.92% | 1.4 |
Eaton Vance Corp | EV | 3.18% | 12.47% | 32.04% | 40.12% | 0.6 |
Aflac Inc | AFL | 3.14% | 18.20% | 44.80% | 5.82% | 3.1 |
Brinker International Inc | EAT | 3.01% | 19.14% | 29.08% | 115.91% | 0.9 |
Bolded are companies with protection values of 1 or greater as well as companies with FCF Payout Ratios below their Dividend Payout Ratios.
A couple of things jumped out at me from this table. First, keeping in mind this is a very small data set, there is a slight inverse correlation between the protection value and the FCF payoutrRatio. This means that the greater the cash pile a company has (and thus the more quarterly dividend payments that it can cover based on its cash reserves) the lower the FCF payout ratio. Now correlation, especially slight correlation, is not causation however it does seem to indicate that certain companies manage their cash in ways that better protect their dividends than others do. Note also that for Aflac (a business that is very much not capital expenditure intensive) and Abbott Labroatories the FCF payout ratio is actually lower than the Dividend Payout Ratio and on the flip side companies that seemed stingy with low dividend payout ratios (like Intel and Conco Phillips) actually have FCF Payout Ratios in the 40%-65% range, making them seem more committed to paying a dividend than previously apparent.
At this point in my search process I have narrowed down my options to fifteen companies which I am now ready to further pare down. I am not eliminating companies that have protection values of less than 1 however I am looking very unfavorably upon companies that demonstrated poor cash flow characteristics like Brinker International and Greif. The poor cash flow of the companies is reflected in the FCF payout ratio but can be seen in its raw form when pulling the data out of the company's cash flow statements. The most useful purpose of a screen, in my mind, is finding out what NOT to buy: by reducing your investment options from the thousands of stocks that are traded everyday down to less than twenty you have already significantly improved your chances of making the correct decision (provided your screening criteria are sound). The hard part then becomes reducing that twenty down even further to the ones that best fit your investing criteria AND that meet your valuation criteria for an entry point. Sometimes even after all your hard work you might be forced to not purchase anything because you cannot get in at a price that provides you with a margin of safety and that my friends is the final barrier protecting you and your money from a research oversight causing financial disaster. Remember, sometimes the best investment decision you can make is to do nothing!
Full Disclosure: Long Intel, Pepsi, and AFLAC
Full Disclosure: Long Intel, Pepsi, and AFLAC
Related Post: Four Criteria For Evaluating Dividend Growth Stocks
DIVIDEND NEWS: HAWKINS (HWKN) PAYS DIVIDEND, MY SHARE IS $9.60
2011 Dividend Tracker (Goal is $200) | |
Quarter 1 (January 1 – March 30) | $3.75 |
Quarter 2 (April 1 – June 30) | $22.47 |
Quarter 3 (July 1 – September 30) | $31.77 |
Quarter 4 (October 1 – December 31) | |
Company | Dividend Payout |
Coca-Cola (October 1st) | $60.33 |
Kimberly Clark (October 4th) | $11.20 |
Hawkins (October 7th) | $9.60 |
QUARTER TOTAL | $81.13 |
Year To Date Total | $139.12 |
69.56% of Goal | |
No comments:
Post a Comment