Free cash flow helps define the viability of the business to generate sufficient cash to meet the operating expenses and replacement capital. A high debt level can be a drain on free cash flow, sometimes to the point the company can no longer afford to pay a dividend.
Current yield defines the money we will earn today. If it is too low we may not be able to cover our living expenses. Inflation is inevitable, especially when the money supply is expanded. A robust dividend growth rate in excess of inflation will ensure we never lose purchasing power.
When selecting a dividend growth stock there is really only one factor that is important – sustainability. As dividend growth investors we are looking for stocks that will continue to raise their dividends into the future.
Below are three things I consider when assessing the sustainability of a dividend growth stock:
Years Of Consecutive Dividend Increases
Inertia is powerful force. Once a company has established a track record of growing its dividend over the decades and developed a shareholder base that expects higher dividends each year, it becomes increasing difficult for management to cut or fail to raise their dividend. No CEO of this type of company wants a dividend cut to occur on his or her watch. There are precious few Dividend Aristocrats remaining and those left enjoy their elite status.Strong Financial Condition
Dividends are paid with cash, not earnings. Ultimately, investors must focus on the ability of a company to generate cash. In addition to the metrics mentioned above, I also look for:Declining Shares Outstanding: I am leery of a company that consistently grows its shares outstanding in the absence of major acquisitions.
Growing Equity: If shares outstanding aren’t increasing, and equity is rising then the business is more likely to generate sufficient earnings to cover dividends and share repurchases.
Business Outlook
With the abundance of information available on the internet, the ability to judge past performance is quite simple. One of the most difficult challenges an investor faces is to determine are the future prospects of a company. Certain questions have to be answered. Is the company in a declining industry? Will it be able to reinvent itself in a way that will allow it to sustain growth? What external force could radically change the prospects of the company? These same questions are being asked by the company’s board, and they are equally hard for management to answer even with full access to insider information.Dividend Stocks With A Sustainable Dividend
Below are several stocks that have increased their dividends for 25 or more years, with a free cash flow payout less than 60%, debt to total capital less than 45%, dividend growth greater than 2% and dividend yield greater than 2.6%:Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device, and consumer products industries. The company has paid a cash dividend to shareholders every year since 1944 and has increased its dividend payments for 56 consecutive years. Yield: 2.61%
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. The company has paid a cash dividend to shareholders every year since 1944 and has increased its dividend payments for 56 consecutive years. Yield: 2.9%
Franklin Resources Inc. (BEN) is one of the world's largest asset managers, serving retail, institutional and high-net-worth clients. The company has paid a cash dividend to shareholders every year since 1935 and has increased its dividend payments for 37 consecutive years. Yield: 3.1%
Walgreens Boots Alliance, Inc. (WBA) is the largest U.S. retail drug chain in terms of revenues, this company operates more than 8,000 drug stores throughout the U.S. and Puerto Rico. The company has paid a cash dividend to shareholders every year since 1933 and has increased its dividend payments for 44 consecutive years. Yield: 3.2%
Community Trust Bank Corp. (CTBI) owns and operates Community Trust Bank, Inc., which provides commercial banking services in Kentucky, Tennessee and West Virginia; and a trust company. The company has paid a cash dividend to shareholders every year since 1988 and has increased its dividend payments for 39 consecutive years. Yield: 3.5%
The ability of a stock to sustain its dividend separates dividend growth stocks from stocks that simply pay a dividend. The latter is quite common, while the former helps define the Best Dividend Stocks in the World.
Full Disclosure: Long JNJ, BEN,
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