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 Payout
How 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 Capital
It 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:
Infinity Property and Casualty Corp. (IPCC) provides personal automobile insurance with a concentration on nonstandard auto insurance.
Yield: 2.2% | Debt/Capital: 27.8% | FCF Payout: 21.4.2%
Weyco Group, Inc. (WEYS) designs and markets footwear for men, women and children under various brand names, including Florsheim, Nunn Bush, Stacy Adams, BOGS, Rafters and Umi.
Yield: 3.2% | Debt/Capital: 5.2% | FCF Payout: 24.9%
Archer-Daniels-Midland Co. (ADM) is one of the world's leading agribusiness concerns, with major market positions in agricultural processing and merchandising.
Yield: 3.2% | Debt/Capital: 28.6% | FCF Payout: 33.6%
Westwood Holdings Inc. (WHG) provides investment advisory services to a wide range of institutional clients, and also provides trust and custodial services.
Yield: 4.3% | Debt/Capital: 0% | FCF Payout: 46.1%
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 200+ 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 IPCC, ADM, WHG. See a list of all my Dividend Growth Portfolio holdings here.
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