If the goal of dividend investing is to find and buy dividend stocks that will continue to raise their dividends, it is not enough to only look at a company’s free cash flow. Many companies generate significant free cash flow, but often that cash is already spoken for in the form of debt obligations.
To gauge how levered a company is, the metric I like to look at is debt to total capital. Debt includes both long-term and short-term debt and is readily available on the liabilities side of the balance sheet. Total capital is a combination of debt and shareholders equity. When you divide debt by total capital a desirable rate is something less than 35%, but I will consider rates up to 50% on a short-term basis.
Many investors look at a return on equity (ROE) when evaluating a company. I have never liked this metric since it ignores debt portion of invested capital. From an ROE approach a highly levered company could show a good return but not be performing well. My preferred return calculation is Free Cash Flow as a percent of Total Capital Employed.
Below are five dividend stocks that with a Debt to Total Capital less than 35%:
Microsoft Corporation (MSFT)- Debt to Capital: 12%- Analysis
Microsoft is the world’s largest software company. It develops PC software, including the Windows operating system and the Office application suite.
AFLAC Inc. (AFL)- Debt to Capital: 24%- Analysis
Aflac Incorporated engages in the marketing and sale of supplemental health and life insurance plans in the United States and Japan.
Nucor Corp. (NUE) – Debt to Capital: 29%- Analysis
Nucor Corporation is engaged in the manufacture and sale of steel and steel products. As the largest minimill steelmaker in the U.S., Nucor has one of the most diverse product lines of any steelmaker in the Americas.
Chevron Corporation (CVX) – Debt to Capital: 9%
Chevron Corporation (formerly ChevronTexaco) is a global integrated oil company that has interests in exploration, production, refining and marketing, and petrochemicals.
Johnson & Johnson (JNJ) – Debt to Capital: 22% – Analysis
Johnson & Johnson engages in the manufacture and sale of various products in the health care field worldwide.
As previously noted, I am currently reworking my dividend analysis worksheets to focus on what’s most important in selecting a dividend stock. A Debt to Total Capital less than 45% , will earn the company a star.
Full Disclosure: Long AFL, NUE, CVX, JNJ. See a list of all my income holdings here.